Cannabis Stocks Are a Bargain Right Now. Here’s Why

2022 was a terrible year for cannabis stocks. In fact, the 70.4% decline in the New Cannabis Ventures Global Cannabis Stock Index was the worst year ever. It followed a very disappointing year that saw the index decline after peaking at over 4 times the low level from early 2020 and resulted in a decline of 89.5% and a new all-time low. The market in 2023 has lifted a bit, but it is not up as much as the broader stock market and the volume is very light. After dropping a stunning 29% in December, the index is up 4.7% in 2023:

The downturn in stocks has a lot of causes but few predicted it publicly in advance. One of the biggest challenges was that the strong cannabis demand after the pandemic hit in 2020 was a big surprise that helped boost the revenues and the stocks, but the subsequent abatement in demand growth also surprised investors and operators. Additionally, many companies producing cannabis in the U.S. have gotten more efficient, which has resulted in a lot of supply now. Less demand and more supply have pressured prices. The low prices have also been hit by the illicit market activity in some states.

Investors seemed too confident in late 2020, when the Democrats won both houses of Congress as well as the Presidency, that legalization would take place potentially. There has been no substantive improvement of the legal status federally of cannabis, and investors now seem overly pessimistic. While I don’t expect full legalization to take place soon, there are some changes that could transpire.

First, cannabis producers could move to the NASDAQ from over-the-counter trading. Canopy Growth, a leading Canadian licensed producer, has changed its structure to have a holding company that it controls buy three cannabis companies and is working to keep its NASDAQ listing and to close the acquisitions in the U.S. If they are able to do so, I expect the leading American operators will mimic the structure and uplist, which could broaden the investor base. They are likely to set up operating companies that they control in order to copy Canopy Growth’s workaround.

In my 10 years of following publicly-traded cannabis stocks, I have never seen prices this low or pessimism this high.  When I look at the valuations, I find prices that appear to be bargains. Some investors focus too narrowly on stocks, picking solely American operators, Canadian licensed producers or retailers or just ancillary companies. The Global Cannabis Stock Index includes all of these and some biotech companies, though there are just two currently. There are not any CBD companies that qualified at the last quarterly rebalancing at year-end. The index is currently about equal-weighted American cannabis companies, Canadian cannabis companies and ancillary companies.

Among U.S. operators, I find the valuations very low, but especially among the not-largest names. I shared my positive perspective on Columbia Care recently. The company is trading at a huge discount to the price of its pending deal to merge with the larger Cresco Labs. If the deal goes through, which I think it will, it should be very good for Columbia Care investors, even if the price is lowered. I also think that if the deal does not go through, the stock should rally. I think a lot of the American cannabis companies will see very high returns in their stocks. The largest 9 MSOs currently trade at an average of just 1.3 times the projected 2023 revenue and 5 times the projected adjusted EBITDA.

In Canada, which legalized for adult-use a while ago, the market is maturing. I am not a fan of Canopy Growth or Tilray, but investors can find good companies that trade below tangible book value. I wrote recently about Village Farms, which collapsed after an equity offering to a price that was very low. It has rebounded a bit but remains very attractive in my view.

I have been a fan of the ancillary sector for a while now. It was down more than the Global Cannabis Stock Index in 2022. This group tends to trade on the NASDAQ, and it appears that a lot of investors jumped in in 2021 and flooded out in 2022. In my view, these companies were hurt fundamentally by their customers cutting back spending to protect cash. I find WM Technology, which used to be known as Weedmaps, to be very interesting. I think the stock could triple in 2023 if it hits a valuation of 3 times its projected 2024 revenue. There are a lot of attractive names in this sub-sector in my view.

Conclusion

Low prices are not always bargains, as they can be a sign of a bad future ahead. I think, though, that cannabis remains a growth industry with positive momentum ahead. There are some extreme bargains, but the typical stock looks attractive to me too. I do not like all cannabis stocks, but there are many attractive stocks across all of the sub-sectors of the market.