Pot stocks are seeing material declines as we head into year-end and in most cases giving up gains over the last two years.  There have been a few events we can point to that might have indicated a turning point for the space and helped feed the change in sentiment. 

Release of leveraged ETFs

If you want to look for indicators that look like the bell ringing at the top, wait for the leveraged ETFs to come out. With some of the first leveraged cannabis ETFs being released in May 2019, timing was pretty good. We discussed how the idea of a leveraged pot stock fund just seemed unnecessary in a past blog and here is how the leveraged fund has done since then:

Not all companies are equal

In the past, the space had traded very closely together. Good news at one company would be rewarded at all companies across the board. Eventually, performance started to diverge and it became very clear with events at CannTrust leading to them losing their license. This brought a dose of reality back to the space that even if the industry growth potential is very real, not all companies will profit from it or are even well run to begin with. This led to a reassessment of companies in a space compared to a period where any company with cannabis in the name seemed to do well.

Institutions have begun souring on the space 

The Green Organic Dutchman (TGOD) recently announced that they cannot find credit from traditional sources with acceptable terms potentially showing a faltering appetite for deals in the space (debt or equity). Hexo recently withdrew its 2020 outlook due to uncertainties in the industry. Finally, analysts across the board seem to be slashing target prices. While we try to stress that investors should take analyst target prices with a grain of salt, for better or worse, these declining targets are likely to pour some cold water on the space in the short-term. 

Markets are giving high valuation companies with losses more scrutiny

Some might want to even blame WeWork for this one. The much talked about company had to pull its IPO due to the markets being unable to get behind the large losses and growth at any cost type of business mode the company has undertaken. This event seemed to act a bit like a wakeup call to markets that then began to apply a higher level of scrutiny to companies that were posting losses. Specifically, if you are a company with high growth, high valuations but low gross margins, you seemed to be in the market’s crosshairs. Companies with higher gross margins seemed to be able to avoid some of the declines. Pot companies fall into the high valuation, high growth (but declining expectations on growth), and lower gross margins. Here are the gross margin trends for a select group:

Some of the above events, in our view, have been catalysts to spark the selloff in the space. At some point these will reach valuations that will be attractive for investors but in the short term, and some might be there already, but it looks like there is going to be a lot of volatility to endure before that happens.

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*The author does not hold a position in any companies or funds mentioned at the time of publishing.