THE BLOG
01/04/2018 13:44 EST | Updated 01/04/2018 13:50 EST

Don't Buy Into The Hype Around Canada's Overpriced Weed Industry

A well-oiled promotional machine hides that skyrocketing cannabis stocks seem more smoke than substance.

Caveat emptor!

Too many investors in Canada's frothy cannabis stocks have been getting very high lately on over-hyped start-ups.

Many of these stocks even include the big boys on the block in Canada's cannabis sector, some of which have added billions of dollars to their market capitalizations while more doubling or even tripling in price just within the last several weeks. Yet their fundamental pictures, such as their sales and earnings, have not changed that much during this period.

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Good examples include Aurora Cannabis (TSX: ACB), which has appreciated as much as 270 per cent since mid-November to a high of $14.88. Then there's MedReleaf(TSX: CMED). It also peaked yesterday, reaching a lofty $31.25, which is almost double what it was during the same timeframe. Emerald Health Therapeutics (TSX.V: EMH) is another high-flyer that shot up nearly 375 per cent from $2.26 on Nov. 16 to a high of $8.34 yesterday.

A cursory glance at the Canadian Cannabis Composite Index illustrates how parabolic this sector-wide rally has been. This benchmark index tracks the performance of Canada's largest industrial-scale cannabis growers. Since its inception at 1,000 basis points on Jan. 3, 2017, the index doubled in value by mid-December. And it has since catapulted to a mind-boggling 3,249 points as of yesterday.

It's been a similarly wild ride for many of the smaller, publicly traded players on Canada's stock exchanges since mid-November. They include MYM Nutraceuticals (CSE: MYM), which has rallied over 250 per cent to as much as $4.00, as well as Friday Night Inc.(CSE: TGIF), which peaked at $1.29 yesterday. That's more than a 300-per-cent premium over its mid-November value.

Investors have been buying into all the hype — hook, line and sinker.

Probably the most glaring example of a stock that is surging like an over-heated engine is Namaste Technologies Inc. (CSE: N), which has gone ballistic in recent weeks. For most of 2017, this Ontario-based company traded at mere pennies a share. It has rallied by a staggering 1,500 per cent since mid-November to as much as $4.40 in late December.

Since then, Namaste has pulled back a little, but it is still trading at many multiples higher than it was just a few weeks ago.

Does this mean that this start-up's business model is 20 times better than it was in early November when it was trading at a little over $0.20?

Does this mean that this start-up is more than 20 times better a company than it was in early November when it was trading at a little over $0.20?

No.

Was it making in excess of 20 times as much money in December than it did the previous month?

No.

Admittedly, the company announced a flurry of deals in December that promise to eventually boost its bottom line. But none of them were of earth-shattering significance.

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Instead, it seems that a well-oiled promotional machine is finally kicking into high gear. And investors have been buying into all the hype — hook, line and sinker.

I was not one of them. I certainly missed the boat by not getting high on all the THC-infused euphoria. But was I stupid to do so? Well, I merely had to remind myself of the following reality: the cannabis business is all about sales and earnings, just like any other business. And on this basis, Namaste has a long way to go yet to justify its inflated share price.

Don't get me wrong. Namaste did a few million dollars worth of sales in vape pens in 2017, which is undeniably impressive. Yet, the company was still losing nearly $7 million as of the last reporting period (the nine months ending May 31, 2017). With about 234 million shares outstanding, it already has a valuation fast approaching $1 billion.

Remember that Namaste is in the ancillary products business. By this I mean that it does not actually grow and sell cannabis or cannabis oils. Instead, it sells vape pens — which is the fastest-growing industry segment for cannabis delivery devices. But vape pens are proving to be increasingly controversial, as some chemists claim that they expose cannabis oil users to dangerous chemical by-products.

Stocks that rise like bottle rockets typically come back down to earth just as precipitously.

Also, Namaste is reliant on industrial-scale growers of cannabis to provide the "fuel" (cannabis oils) that power its products. Ultimately, this could prove problematic. Which is because industry experts and the federal government, alike, suggest that there will be a shortage of cannabis once it becomes legal as a recreational product this summer.

This supply shortage will not hurt the business of Canada's industrial-scale growers of pharmaceutical-grade cannabis. But it could ultimately prove deleterious to Namaste's bottom line. After all, there's no point in consumers rushing to buy vape pens if they can't get cannabis oils to put in them.

Does any of this matter right now? Apparently not.

Investors continue to pile into Namaste every day, spiking its share price to dizzying new heights. However, savvy stock market pundits will always tell you that spikes are almost always followed by harsh corrections. Simply stated, stocks that rise like bottle rockets typically come back down to earth just as precipitously.

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Will this prove to be the case for Namaste? Well, as long as investors keep passing the vape pen around the room with giddy exuberance, then I guess Namaste and other high-flying uber-performing cannabis stocks will continue to fly high.

But when the buzz wears off a little and prices drop, don't say I didn't warn you.

The takeaway here is that investors who are new to the excitement of the cannabis asset class just need to step back and exercise a little circumspection before jumping in with both feet. There's an old maxim in the stock market that goes as follows: bulls make money and bears make money, but pigs get slaughtered.

Once again, investors: caveat emptor!

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