Is It Too Early to Invest in Cannabis Stocks?

By 2027, the cannabis industry could be worth $82.3 billion, according to estimates from MarketsandMarkets. Many analysts are projecting significant growth for the sector as countries and states legalize it — either fully or for medical use — resulting in more opportunities opening up around the world.

But that isn’t a guarantee, and those growth projections are based on many assumptions. If and when legalization actually takes place in the U.S. and other parts of the world remains anyone’s guess.

For investors, it raises the question of whether it’s too early to invest in the cannabis industry. Until legalization in a top market like the U.S. takes place, companies might be scrambling to find growth opportunities.

And by the time legalization does happen (assuming it does at all), the industry could look a lot different. Below, I’ll look at some of the risks of investing in the sector right now, and whether it makes sense to do so.

Many marijuana companies are unprofitable

Oftentimes when you see a marijuana company report positive net income, it’s due to gains on the revaluation of inventory or nonoperating items. When looking at operating income, however, the businesses are usually well in the red.

TLRY Net Income (Quarterly) Chart

TLRY net income (quarterly) data by YCharts.

A lack of profitability hasn’t always hurt the cannabis industry since investors have accepted that it will take a while to get to breakeven. But a significant problem with a consistently unprofitable business is that it can lead to a significant outflow of cash.

Cannabis companies are often burning tons of cash

If a business isn’t generating positive cash flow from its day-to-day operations, it can lead to dilution since it might resort to share offerings to raise cash unless it is sitting on a ton of money.

TLRY Cash from Operations (TTM) Chart

TLRY cash from operations (TTM) data by YCharts. TTM = trailing 12 months.

Canopy Growth (CGC 1.65%) has an abysmal track record for cash burn, but because beer maker Constellation Brands invested $4 billion into the company back in 2018, it isn’t in a dire situation. As of Sept. 30, 2022, Canopy reported cash and short-term investments totaling 1.1 billion Canadian dollars ($821.9 million). It isn’t running out of cash anytime soon, but its situation isn’t sustainable. Sooner or later, a lack of money could become a big problem for the business.

Growth has stalled

Perhaps the most troubling trend of all in the industry is that these companies can’t even be counted on for consistent sales growth anymore. Revenue growth was often enough to excuse a lack of profitability. But as that appears to be gone, at least for now, investors have been left wondering whether it’s worth buying shares of cannabis stocks.

TLRY Revenue (Quarterly YoY Growth) Chart

TLRY revenue (quarterly YoY growth) data by YCharts. YoY = year over year.

I have excluded SNDL (SNDL 1.30%) from the above chart as its results would skew the data. The company has achieved some incredible growth, but it has done so by relying heavily on acquisitions.

Most investors should avoid the industry right now

The main argument for investing in cannabis stocks centers around the promises of growth and long-term potential. But because that largely depends on hopes of U.S. marijuana legalization on the federal level, it can be a risky strategy;  there’s no guarantee that it will happen anytime soon. In the meantime, losses might be mounting and businesses could be running out of money.

For the vast majority of investors, it is too early to invest in the cannabis industry. There is a significant danger that you can incur deep losses while waiting for legalization, as many investors have already.

Unless you have many investing years left (at least 10) and are OK with the high risk that’s involved with investing in cannabis companies, you’re better off waiting until legalization actually takes place in the U.S., assuming that it does at all.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Brands. The Motley Fool recommends Sndl. The Motley Fool has a disclosure policy.