Given that it’s 420 day it’s worth having a look at some of the cannabis stocks. Sundial Growers (NASDAQ: SNDL), Aurora Cannabis (NASDAQ: ACB), Verano Holdings (CNSX: VRNO) and Tilray Brands (NASDAQ: TLRY). All of them are massively down and yet we know very well that the cannabis market is expanding. So, how can this be? The answer lies in something uncomfortable for us as investors, even as it’s what makes us all so incredibly rich as a society.
Looking at the performances Aurora stock is down 96% over a 5 years period. Sundial stock down 93% over the same time span (even though it’s not been quoted the whole period), Verano stock down only 66%, but that only listed last year, and Tilray stock is the best of the bunch at only 74% off over 5 years – although it’s more like 95% off its highs.
So, what’s happening here? We know we’ve a newly legalising and expanding market, consumption – legal consumption at least – is up, so why aren’t producers and providers doing well? Given that the performance isn’t varying across these four – and they were a pretty random selection of the sector – then it’s got to be some sectoral problem. Instead of, say, the management partaking in a bit too much of their own production.
One answer is that the manner of legalisation has been simply appalling. California, for example, has been able to lard the newly legal trade with such taxes and bureaucracy that the still extant illegal trade is still cheaper and arguably of better quality. As such the legal trade is thought to have less than a majority of the market even now. Other places aren’t so bad – nowhere does bureaucracy and taxes like California – but the irruption of legality into the supply chain is disappointing everywhere. It’s almost like asking bureaucrats to design a market doesn’t work or something.
But the deeper and truer answer is that this is the way that free market capitalism does work out all too often. This is an illustration of what Warren Buffett says – he likes buying businesses that have a “moat”. That is, a protection against competition from other producers who might come and eat market share and or profits. OK, so, what’s the moat around a cannabis producer?
Everyone’s starting from roughly the same point. It’s not exactly a difficult thing to grow, transport nor sell – teenagers have been working out how to do this on their own for generations now. There are no specific brands to protect and while gaining a licence can be pettifogging in detail it’s widely possible.
The end result is that there are many producers in the market. This then competes away any gross margin and or profit that can be made. In effect, this is what happens to capitalism in a free market. Where there aren’t whole Warren Buffett moats, where competition is free and fierce, then profits are in very short supply indeed.
Another way to put this is that no one cannabis company is doing well as an investment simply because there are so many of them. The end result of this being that as a sector it’s quite possibly one we should shy away from. At least until there’s any proof that any one of them is going to be able to dominate the industry and thus build good margins.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.