Investing in cannabis stocks can be like looking for a goose that lays golden eggs — but finding only lemons much of the time. Between the ever-present hype about questionable companies and the industry’s struggles with…
efficiency, even savvy buyers can make mistakes; I know I’ve made a few!
The good news is that becoming a wiser investor is easier than it may seem. And today, I’ll be sharing four of my best tricks for identifying the best marijuana stocks so that you’ll be equipped to succeed.
1. Don’t limit yourself to pure plays
There’s more to the cannabis industry than companies that grow cannabis and then sell it directly to consumers. In my view, some of the most lucrative marijuana stocks are those that never handle the substance at all.
Take Scotts Miracle-Gro (NYSE:SMG), GrowGeneration (NASDAQ:GRWG), and Innovative Industrial Properties (NYSE:IIPR) as examples. Scotts sells cultivation equipment and plant food, whereas GrowGeneration sells hydroponic growing gear. Innovative Industrial doesn’t sell anything at all; its business model entails buying indoor cultivation space from marijuana companies and then leasing it back to them. All three businesses feed directly into the cannabis industry’s most basic needs, and all three are positioned to grow alongside the industry itself as a result.
The advantage of picking one of these stocks instead of a pure-play marijuana company is that they’re much more robust. If the market price of cannabis rises, it could seriously disrupt margins for a retailer, but it wouldn’t harm any of the three businesses I listed. Likewise, if the consumers in a given geographical market have a set of product preferences that a distributor isn’t equipped to match, that distributor won’t be able to compete effectively. But the companies I listed won’t have any issues.
So, don’t limit your search for marijuana stocks to those whose business models are purely based on cannabis sales. Doing so could lead you to miss a few of the best options out there — and potentially expose yourself to more risk.
2. Profitable is preferable, but steadily improving margins are fine, too
Because the cannabis industry is still immature and growing rapidly, profitability is hard to come by. Most companies are focused on growth rather than becoming more efficient or rewarding shareholders.
That means investors don’t have many profitable companies to choose from, though they can probably expect to have more choices in the future. In the meantime, bargains might be found in companies that are quite close to being profitable, like Cresco Labs.
If you can’t find anything that suits your fancy that’s firmly profitable, don’t be afraid to opt for a business that has been posting better margins while still growing revenue during each quarter for the past year or so.
But if you’re looking at a pure-play company, be sure that its profits are increasing as a result of increasing operational efficiency rather than fluctuations in the market price of cannabis. Many marijuana businesses are tenuously profitable when prices are low, but…
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