In contrast to previously optimistic expectations, United States and Canadian marijuana stocks have been plunging in value over the past week, showing little signs of recovery as many top producers suffer double-digit declines over past 24 and 48 hours.
Ever since October 17th, the much-anticipated day when recreational cannabis was legalized, major stocks have continued to plunge in value. Canopy Growth Corp (TSE: WEED) declined 24% from $65.25 to $49.50. Aurora Cannabis Inc (TSE: ACB), despite its first day of being listed on the NYSE, lost close to 12 percent today and currently sits at $10.08, a 28 percent decline from last week.
Both Tilray (NASDAQ: TLRY) and Aphria (TSE: APH) stocks have tumbled, losing 25% and 27% respectively between the two. When the markets opened on Tuesday morning, Tilray plunged from $122.60 to 103.00 overnight, but have since recovered that lost value.
Even the largest cannabis exchanged-traded funds, such as the $750 million Alternative Harvest ETF, fell by 9.5% on Monday, totaling a 22% loss over the past five trading days. The Horizons Marijuana Life Sciences ETF also fell similarly, down 24.3% over the week. Just one week ago, both funds were at record highs but now sit at 4% below their values at the start of 2018.
Traders have been quick to blame a number of reasons for this decline, with the main concern being that retailers are struggling to cope with supply shortages plaguing the early days of legalization. Dispensaries were already running out of marijuana by the second day of demand. With many producers acknowledging they won’t be able to ramp up supply for many months, facing issues such as a lack of skilled labor among other things, these growing pains appear to be a major reason for the decline.
Paul Rosen, CEO of Tidal Royalty and investor in U.S cannabis companies, mentioned that this volatility is to be expected. According to The National Post, he went on to say that “the markets were just a little grumpy for macro reasons. There’s no new bit of information that would’ve justified this sell-off,” adding that “if the volatility or potential volatility is too stressful – there’s too much anxiety – please do not buy [cannabis-based] stocks.”
Others, however, have speculated that perhaps the cannabis industry has been riding on investor enthusiasm rather than solid fundamentals. Brian Pinchuk, portfolio manager at Lorne Steinberg Wealth Management, expressed similar concerns. “It is important to remember that the value of a business is, and will always be, a function of its financial strength, earnings and growth,” he said according to The Montreal Gazette. “With little earnings and a lack of measures on which to anchor a valuation, much of the sector remains speculative and prices for perfection…it will not be longer before a shakeout occurs after the cannabis ‘gold rush’ runs its course.”
In some ways, these concerns seem valid. Most marijuana stocks are expensive when looked through the lens of traditional valuation metrics such as price-to-earnings, price-to-book, and price-to-sales ratio. Tilray, for example, still has a price-to-book ratio of 233, price-to-sales ratio of 363, and has no earnings to value yet.
On the other hand, some would argue that these traditional valuation metrics shouldn’t apply for such a young industry with the extreme growth potential it has. Since these metrics look at past results, not projected market trends, if the growth of the cannabis market is anywhere similar to what experts think it will be in the future, these stocks should see a significant rise in sales, book value, and profit margins – justifying current valuations.
While few question the long-term growth potential of the cannabis market, it’s becoming clear that the once optimistic expectations for the post-legalization era of marijuana stocks is anything but that.