The skinny on pot

From the December 2017 print edition

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.

In addition to writing for PurchasingB2B magazine, I instruct in a variety of investment and financial planning courses with both the University of Toronto School of Continuing Studies and George Brown College. A question I’ve been getting a lot lately—in particular from my George Brown College students—is what do you think about marijuana? No, the students are not asking about my personal preferences when it comes to vice. What they are inquiring about is what I think of this sector as an asset class to invest in.
Very shortly, it will be fully legal to own these previously banned products in this country. According to a recent report from Deloitte, the market value of recreational marijuana approaches $9 billion. And this is the recreational value only. One of the primary reasons, it seems to me, why some who were previously opposed to legalizing marijuana is that many people who are chronically in pain find tremendous relief from the active ingredient in marijuana. This means that the $9 billion figure should be understood as a low-ball estimate.
History tells us that investing in “sin” stocks has been quite lucrative. While it is true that the tobacco companies are under siege from governments around the world, a company like Altria is able to churn out dividend after dividend. Over the past generation, we have seen consolidation in the beer industry with the mergers of Coors and Molson, and In Bev and Budweiser. Fewer players mean economies of scale and less competition which are not so great for consumers, but something that investors appreciate. That suggests that investing in marijuana may be a very good idea.
Yet I have not taken the plunge and there are a few reasons for that. This is an industry in its infancy. It is difficult to project cash flows with any accuracy, so how can I possibly guess what is fair value for shares of companies that are currently losing money and are cash flow negative as they try to ramp up to meet demand? At this point, we don’t know exactly how marijuana will be both regulated and taxed, which means that we don’t know whether the government will allow the industry to be profitable in Canada. And there’s one more wild card, which I’ll reveal later in this column.
I have been investing seriously for the past 25 years and I’ve found that the most reliable way to ensure that my hard-earned money isn’t flushed down the drain is to go through rigorous cash flow analysis. When you buy shares, you know with certainty what they cost you today. What you don’t know with precision is what dividends you will receive in the future, and what you might sell those shares for down the road. But unless you can make these projections with some accuracy, it seems to me that you’re not investing. You’re speculating.
Previously, I explained the reason why so many people have come around on the idea of legalizing marijuana. But this isn’t what’s motivating governments around the world. If the retail market for marijuana is (let’s round off) $10 billion in Canada and the government can capture a significant chunk of that…well, that’s not chump change! And traditionally “sin taxes” have been easier to justify that something like HST or higher income tax rates. Then the question is what will remain for investors after government gouges out its share? That’s one more risk factor.
Finally, and this is the decisive reason why I’m skeptical about the long-term profitability of marijuana stocks, is that it’s so easy to grow! Once there is widespread acceptance, I can envisage that in backyards across Canada there will be marijuana plants beside tomato plants. The growth of marijuana will be a thriving cottage industry. There will be an active market in selling seeds, specialty fertilizers, and a variety of garden products. And this will put pressure on the margins that the big producers will receive. You can almost think of it as the impact that Uber has had on the traditional taxi industry.
All this said, I think it’s not unlikely that there are at least a few companies whose shares will see meteoric increases over the next decade with the legalization of marijuana. And if I had the time and expertise to dedicate hundreds of hours researching this category, then I might feel confident enough to invest. But I don’t. And what that means is I’ll stick with drinking beer (when it comes to my personal vice) and stick with investing in companies that make beer (when it comes to investing in personal vices) even if it means missing the possibility of a big payday from marijuana down the road.