Friday File: More Pot Sermonizing, a Portfolio Update, and some Hedging

What does it feel like to miss a bubble? Plus updates on Insurance stocks, Disney, Altius, Fairfax India and more...

By Travis Johnson, Stock Gumshoe, September 21, 2018

Have you been watching what’s going on with the trendy pot stocks lately?

Holy crap.

This reminds me now of 1999 more than it reminds me of the cryptocurrency bubble of this past winter — these larger marijuana companies, like many of the dot com companies (and unlike most cryptos, of course), are real businesses with real sales…. but they’re being bought with no rational regard to the current or feasible financial performance of those businesses. I fear this is going to end really, really badly for a lot of companies and investors… be careful.

Stocks that can surge overnight by 50% on no news, like Tilray did earlier in the week (it more than doubled in less than a week), can fall 90% just as fast — sometimes faster. If you’re trading these stocks because you love the rush (and I don’t blame you, it can feel absolutely exhilarating), do make sure not to “get married” to these companies… they are obviously wildly priced and completely unsustainable at these valuations even if every beer drinker in Canada switches to marijuana on October 17.

That doesn’t mean they’re bad companies, or that you have to sell, of course. Just that the prices don’t make any sense to me… that doesn’t mean they can’t go up another 500%. No one knows when you’ve hit the tip of that spike in the stock chart until after the fact. Just know that the stock charts here resemble past bubbles, and those generally experience their greatest inflation just before the pop, when everyone’s desperately trying to leap aboard the runaway train.

And yes, I know that Constellation Brands paid $5 billion for a toehold in Canopy Growth, and that other big companies are looking to get into marijuana. That’s a strategic imperative for them, and a hope that they can buy more growth as the beer or soda market softens… big companies and smart CEOs are not immune from catching bubble fever. Yahoo paid $1.2 billion for an online greeting card company in 1999, and bought Broadcast.com from Mark Cuban for an insane $7.5 billion that same year. Broadcast.com was acquired for about $1,000 per free user, in a world where online advertising did not yet generate any actual money — if I could get that valuation for Stock Gumshoe today I’d sell, too, and buy myself a professional basketball team.

OK, fine, that’s not nearly enough to buy a basketball team, we’re still a small bunch of folks here at Stock Gumshoe… but still, that’s a lotta cabbage. Maybe a professional indoor lacrosse team? All those 1999 numbers are adjusted for inflation, by the way.

When rationality returns to the Canadian marijuana stocks, I’d guess that the strong companies who do have real businesses and sustainable brands or other competitive advantages will survive (like Cisco or Microsoft in 2000) but that they’ll fall in price from these levels by something like 50-75%, while the weak ones (Webvan, Pets.com) fall 90%+ and have their assets bought up by the survivors, or just disappear entirely. Everything is faster now than it was in 2000, so the bubble could also disappear more quickly, I don’t know, but the Nasdaq bubble took almost two years to really inflate crazily and about a year to fully “pop.”

And yes, as far as I’m concerned it is a “when,” not an “if” — some of these are objectively “real” companies with growing operations and supply chains and distribution, particularly the biggies like Canopy, and the underlying marijuana business will obviously grow a lot in Canada with full recreational legalization… but I think that’s more than priced in to every pot stock I’ve looked at. They’re agricultural and consumer products companies, and some of them are just wholesalers… they’re not creating something out of nothing, and they don’t have any magical powers. At some point, they will be valued by investors based on their revenue and profits and the potential and feasible near-term growth of those numbers, so if you’re trading these stocks please make sure you’re ready for that… when you’re trading in a bubble market the adrenaline rush can be fantastic and exciting, but that feedback twists your mind and some people leave rational thinking behind and begin to believe that these are “investments” that are real and sustainable… and that often means that speculators in these kinds of stocks become lemmings — don’t jump off the cliff just because everyone else is doing it.

Tilray (TLRAY) started the month with a $5 billion valuation, entered the week at $10 billion, then hit at a $20 billion valuation on Wednesday morning before coming back down to $12 billion this morning… and it might be valued by the market at $50 billion in a week, I don’t know, but I’ll be surprised if it’s worth $50 a share in a year or two (that would be a $5 billion valuation at this share count, though they’ll almost certainly sell more shares along the way)… that’s not because I know anything particularly about Tilray, but because it’s one of a massive number of companies in what will be a ruthlessly competitive and therefore probably loss-making market that just can’t be that big, that fast.

I should be clear: I’m not shorting these stocks, because I could (of course) be just plain wrong, and I’m not crazy (they can stay overvalued for years if I’m wrong about the timing, and bubbles can become dramatically larger than any rational person might imagine — shorting into a bubble is a good way to lose your house), but over the long term, shorting seems far more rational than “buy and hold” for most of these stocks at these valuations. The market capitalization of these companies is absurd, and you probably don’t need me to tell you that, but predicting when it gets “too absurd” is another thing entirely, and a bet that has lost a lot of short sellers a lot of money in just the last week or two.

No, I don’t have strong feelings about marijuana legalization, other than to be a little bummed that I smell more skunks than I used to when I walk the dogs, and a little dismayed that vaping is so hugely popular with kids just as more pot-spiked vaping supplies are hitting the market (a popular platform for students running for high school elections this fall in Massachusetts, I hear, is “I’ll get the vapers out of the bathrooms”).

And yes, I do still have some exposure to medical marijuana — though only through a US marijuana landlord, Innovative Industrial Properties (IIPR). That’s a high-risk investment, too (and leapt over my “buy under” price of $45 to close out the week), but has a pretty solid foundational asset value that should keep losses to 50% or so if the business shifts dramatically and all their US medical marijuana grower tenants go bankrupt, which probably won’t happen quickly and might not happen at all.

And Canada is, of course, a great unknown — I could be entirely wrong, and we could