Interest in investing in the marijuana sector has risen as cannabis stock prices have climbed after voters approved recreational and medicinal marijuana use in six states in November.
Investors can now gain exposure to the cannabis industry by choosing from 10 cannabis companies in North America that have billion-dollar market capitalizations, including U.S. companies with $2 billion to $5 billion market caps. They can also add cannabis exchange-traded funds to their portfolio as several of them began trading in 2019.
The U.S. now has 36 states and two territories — Puerto Rico and the U.S. Virgin Islands — that allow the use of medical marijuana, while 15 states, Washington, D.C., Guam and the Northern Mariana Islands can legally sell cannabis to adults.
Here’s why investors should add exposure to marijuana in their portfolio, the top stocks in the space and how to invest in the best marijuana funds:
— Why investors should buy cannabis stocks.
— The top cannabis stocks to watch now.
— How to invest in cannabis ETFs.
Why Investors Should Buy Cannabis Stocks
Marijuana stock prices started rising before the November election in anticipation of more states legalizing recreational use.
Yet it’s not too late for investors to add positions to their portfolios, says Timothy Seymour, founder of Seymour Asset Management in New York and portfolio manager of Amplify Seymour Cannabis ETF (ticker: CNBS), whose top three holdings are Canopy Growth Corp. ( CGC) at 12.1%, GrowGeneration ( GRWG) at 11.5% and GW Pharmaceuticals ( GWPH) at 11.2% as of Nov. 17.
“There are longer-term plays for some companies that are already out there and winning,” he says.
There are also some stocks prices that remain cheap — the companies will be trading on earnings before interest, taxes, depreciation and amortization, or EBITDA, multiples that will be very attractive companies to other growth industries, Seymour says. By 2022, some cannabis stocks could trade at seven to eight times EBITDA.
Investors need to remain thematic with their choices and focus on companies with balance sheets that are defensible even if the economy dips. One factor to watch for is that access to capital is “still very tight, and investors want to invest in companies that can survive today and tomorrow,” he says.
“You have to invest with an eye on capital structure and understand which companies won’t have diluted equity raises around the corner or balance sheets imperiled with a lot of debt and equity warrants,” Seymour says.
The Top Cannabis Stocks to Watch Now
The top four U.S. cannabis companies are good additions to an investor’s portfolio: Curaleaf Holdings (CURLF), Cresco Labs (CRLBF), Green Thumb Industries (GTBIF) and TerrAscend Corp. (TRSSF), according to Seymour and Jason Spatafora, co-founder of marijuanastocks.com and head trader at truetradinggroup.com.
Curaleaf, a Wakefield, Massachusetts-based vertically integrated cannabis operator, operates in 23 states with 93 dispensaries and has 23 cultivation sites and more than 30 processing sites. The company reports third-quarter earnings on Nov. 17 and is trading at a 49% discount compared to the average U.S. operator, wrote Russell Stanley, a Beacon Securities analyst in a Nov. 6 report.
Cresco Labs, a Chicago-based multistate operator, is also trading at a 22% discount compared to other U.S. operators with footprints in several states, Stanley wrote in an Oct. 14 report. The company reports third-quarter earnings on Nov. 18. Cresco reported second-quarter revenue of $94.3 million — a 42% quarter-over-quarter increase — 30% sequential revenue growth in all of the U.S. markets aside from Massachusetts and adjusted EBITDA of $16.5 million, or 419% growth from the previous quarter. Cresco Labs is operating in nine states, has 15 production facilities, 29 retail licenses and 19 dispensaries.
Green Thumb, a Vancouver and Chicago-based national cannabis consumer packaged goods company and retailer, reported revenue of $157.1 million in the third quarter, an increase of 31.3% quarter over quarter and 131.1% year over year on net income of $9.6 million. As of Sept. 30, Green Thumb has assets of $159.1 million, including $78.1 million in cash and total debt of $97.1 million.
Investors should add Green Thumb to a portfolio because of its “blow out” in third-quarter earnings, Spatafora says.
TerrAscend, a New York and Toronto-based North American cannabis operator, is a good addition to a portfolio, Seymour says. The company’s footprint includes New Jersey, where it has a 140,000-square-foot indoor cultivation greenhouse that has post-harvest manufacturing capabilities. The company recently announced a 25% expansion at its Pennsylvania cultivation facility to keep pace with strong demand. The passage of recreational marijuana in New Jersey will help the company generate more sales.
“It fits the model and has allowed them to be highly profitable in a limited license state where they are an early mover and the strong regional synergy that will play out here,” Seymour says. “Their brand and the experience at the retail dispensary is considered higher end since it is more sophisticated.”
The company reported preliminary third-quarter sales of $51 million Canadian dollars, for 8% sequential and 90% year-over-year growth, and adjusted EBITDA of $17.8 million Canadian dollars, an increase of 56% sequentially. Earnings will be released Nov. 19.
The company is focused on only a handful of states that are east of the Mississippi where a limited license framework puts more of a moat around the business, Seymour says.
“Limited license states are more profitable, and TerrAscend has a focus on being either the dominant or one of the dominant players in the states they operate in,” he says.
Investors should plan on holding Trulieve Cannabis Corp. (TCNNF) for a longer period of time since the company has more than 50% of market share in Florida and is expanding rapidly, Spatafora says.
Trulieve Cannabis reported third-quarter earnings on Nov. 17 with revenue of $136.3 million, an increase of 13% on a quarter-over-quarter basis. The company also reported adjusted EBITDA of $67.5 million, or 50% of revenue, which marks the 11th quarter of consecutive growth and profitability. Trulieve has cash of $193.4 million as of Sept. 30.
Innovative Industrial Properties ( IIPR) is a real estate investment trust, or REIT, that focuses on the regulated U.S. cannabis industry and purchasing specialized industrial real estate assets for the regulated medical-use cannabis industry. The company’s strategy is to continue to acquire medical-use cannabis facilities in the U.S.
IIRP reported third-quarter revenue of $34.3 million, or a 197% increase from the prior year’s third quarter, on net income of $18.9 million. The company paid a quarterly dividend of $1.17 per share on Oct. 15, a 10% increase over the second quarter of 2020’s dividend and a 50% increase over the third quarter of 2019’s dividend.
“They are attractive not only for the capital appreciation potential but for their dividend consistency as they have paid consecutive quarterly dividends to common stockholders since the second quarter of 2017,” says Michael Underhill, chief investment officer of Capital Innovations in Pewaukee, Wisconsin. “The financial model combined with the fact that sales of state-regulated cannabis in the U.S. will grow from $12.4 billion in 2019 to nearly $34 billion in 2025 sets the stage for continued growth and income for investors for several years.”
[SEE: 6 Thematic ETFs for 4Q 2020.]
How to Invest In Cannabis ETFs
Buying individual stocks is a better bet since the majority of cannabis ETFs are passively managed and only rebalance every quarter and have serious drawbacks, Spatafora says.
“Most of these ETFs will have a certain amount allocated to a number of companies where the top five marijuana stocks are good, but then there is a huge drop off in quality in the other stocks,” he says. “Everything else is more risky.”
Portfolio managers in actively managed ETFs can divest companies at the first sign of a problem, such as when Canadian regulators found out that CannTrust Holdings (CNTTQ) grew cannabis illegally, Spatafora says.
An actively managed fund can add or decrease holdings in its stocks rapidly and take advantage of new deals as they emerge or “trade out of names that are less interesting,” Seymour says.
Adding ETFs to a portfolio is a good strategy for investors seeking a long-term approach or for seasonal trades. Individual cannabis stocks might generate higher profit margins.
The number of marijuana ETFs has increased over the past several years. The actively managed AdvisorShares Pure US Cannabis ETF ( MSOS) began trading in 2020, has an expense ratio of 0.74% and only invests in U.S. multistate operators such as Green Thumb Industries, Cresco Labs and Curaleaf.
Several marijuana ETFs received approval from the U.S. Securities and Exchange Commission in 2019.
The AdvisorShares Pure Cannabis ETF ( YOLO) began trading on the NYSE Arca in April 2019 and charges an expense ratio of 0.75% since it’s also actively managed. The ETF tracks U.S. and Canadian companies, and the top three holdings are Innovative Industrial Properties at 10.3%, Village Farms International ( VFF) at 9.6% and GrowGeneration at 7.2%.
The first U.S.-focused marijuana ETF, the Horizons US Marijuana Index ETF (HMUS), began trading in April 2019 in Canada and has a management fee of 0.85%. The ETF owns 11.4% in Curaleaf, 11.1% in Cresco and 10.7% in Green Thumb Industries.
The Cannabis ETF ( THCX) began trading in July 2019. The fund holds 28 stocks and has an expense ratio of 0.7%. The ETF is passively managed and tracks the Innovation Labs Cannabis Index. The top three holdings are GrowGeneration at 7.9%, Canopy Growth at 6.8% and Aphria ( APHA) at 6.5%.
Another fund to consider is the ETFMG Alternative Harvest ETF ( MJ) that was launched in 2015. The fund had $772 million in assets as of Nov. 18 and an expense ratio of 0.75%. The passively managed ETF holds large positions of 8.7% in Canopy, 6.4% in Cronos Group ( CRON) and 6.1% in Tilray ( TLRY). MJ allows investors to buy calls and puts and short the ETF.
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Correction 11/18/20: A previous version of this story used an outdated figure for the ETFMG Alternative Harvest ETF’s assets.