"Yes
Was the start of my last jam
So here it is again, another def jam
But since I gave you all a little something
That we knew you lacked
They still consider me a new jack
All the critics you can hang 'em
I'll hold the rope
But they hope to the pope
And pray it ain't dope"
- Public Enemy, Don't Believe The Hype
There have been few market sectors that have performed as badly as cannabis stocks.
While I got beat up, my losses were far from and nowhere near the general and large decline in the industry's shares over the last few years.
Here are some lessons that I have relearned about investing in cannabis stocks over the last two years, and for that matter, in most equities over my investment career:
* Be Independent In View: Pool all your resources and come up with a series of probable scenarios and weight each scenario by probability in order to develop a calculus and range of "values" in seeking a realistic upside reward vs. downside risk and in an attempt to ascertain a "margin of safety" in each investment you make.
* Be Realistic: In establishing the exercise (above) of evaluating an industry or company's prospects, avoid the hyperbole and exaggerated outcomes of others. Use common sense and logic of argument. At the very least, be objective - at most, cynical when evaluating their input.
* Fundamentals Trump Everything: While investors were starry eyed about the longer term promise of cannabis (and the large total market, TAM) the fundamentals were steadily deteriorating in 2021-22.
Analysts and investors steadily ignored these eroding fundamentals - I was late too but started expressing concern in late 2021/early 2022 in a series of negative columns - focusing too much on their perception of the potential treasures of the too distant future.
* Evaluate The Orbit of Your Outside Resources: Avoid the confident of view in a world of uncertainty and with a wide range of outcomes, stay away from conflicted and biased paid "advisors" to companies, as they typically have an agenda that differs from yours. Keep these "types" away from your children and from your portfolios.
The value of the "insights" of paid consultants, in particular, is inverse to the number of their tweets or comments that they make on social media! To this day they are still confidently tweeting out their bullish pablam with frequency! With the benefit of hindsight there might have been more tweeps and tweets about cannabis than any other market sector extant. I and others should have recognized this earlier!
* Analysts Are Notoriously Bullish - Take Their Views With A Grain of Salt": I have run several sell-side research departments and one buy side research effort - so I know of where they come.
There are exceptions, but in the main - and partially to maintain company relationships - brokerage firms (and the sell-side) exist to sell you merchandise. Their estimates are too often "group stink", gathered in a herd of closely gathered forecasts that essentially mirror company guidance.
Over time, analysts have universally presented the cannabis industry as a ticket to high returns with low risk - they were woefully inaccurate. Not surprisingly they are still unrepentant about being so wrong-footed and still mostly bullish!
* Seek Out Competitors' Input: Try to speak to competitors to better and more objectively assess the lay of the land as they can often tell you more than analysts, stock brokers and/or managements.
* Talk to Managements But Don't Take Their Bullish Views as Gospel: In the extreme Warren Buffett once said that corporate managers sometimes lie like Ministers of Finance on the Eve of Devaluation. The Oracle's words have some substance.
* (Almost Always) Seek Out Superior Managements With Solid Accountants/Auditors and Financial Controls: Again, in retrospect, many cannabis equities failed to fulfill this characterization and recommendation. Remember when an accounting problem is revealed, more quickly as there is never just one cockroach!
* Be Cynical With Regard to The Timing and Anticipation of Regulatory Change: Our representatives in Washington, DC are not a group you can count on to produce timely and effective legislation - regardless of how compelling. With our political leaders' growing party bias things have worsened. Change comes even more slowly, if at all, as cannabis investors have learned with regard to the steady promise of federal legislative initiatives (SAFE Banking, uplistings, etc.). As Gretchen was told in the movie Mean Girls, "stop trying to make fetch happen, its not going to happen."
* The Three Worse Words in Investing Are... "Total Addressable Market (TAM)": TAM is a crutch and often hard to refute because it is an abstract or conceptual factor, many years out. My experience, and it is certainly the case for cannabis stocks, that it is often subject to exaggeration and hyperbole.
I recall seeing charts of extraordinary low 3-5 year EBITDA and sales multiples based on the projections of the analytical community. Some are still delivering them with regularity! Those estimates (based on TAM) were not worth the cost of the ink needed to produce them.
* When Looking for a "Bottom," Selling Call Premium Against Unloved Stocks Can Insulate Investors From Some Losses: This is exactly what I have done throughout the painful drop in cannabis stocks. I have consistently been short (high implied volatility) AdvisorShares Pure US Cannabis ETF (MSOS) calls throughout my losing investment in the sector.
* A Low/Conservative Weighting (Particularly Of Out of Favor Sectors That Are Trending Lower in Price) Can Also Insulate Investors From Losses: I have never had more than 5% of my portfolio in cannabis stocks, sometimes far less.
Bottom Line
One of the reasons my Diary is helpful to me is that when I make investment boners (which, in some periods, occur with frequency) I can go back and evaluate why - in the hope that I won't make the same mistake again.
My unprofitable sojourn into cannabis stocks are a good example of employing some discipline in a bad investment.
But today's opening missive has broader implications beyond weed.
Learn from my mistakes, I try to.
(This commentary originally appeared on Real Money Pro on September 19. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)
