Paul Vs The Market

Shall we play a game? See how many (intentional and maybe unintentional) euphemisms for marijuana you can find in my post below and put your answers in the comments. Winner gets a hearty round of applause from me!

Have you heard about Tilray (TLRY)? It’s the marijuana stock which has gone from $53 a share to $300 a share and back down to $100 a share… just in the past month! That’s not even as crazy as the single day where trading was halted 5 times due to volatility and went from being up 90% (in one day!) to briefly being negative, to finally finishing in the green.

I’m not usually somebody who gets too hung up on valuations, but even I have to admit that things have gotten way out of whack with many of these marijuana companies. This seems like a classic case of the hype getting ahead of the fundamentals and too many people chasing a pot of gold by investing in the limited number of publicly traded cannabis companies out there. The demand is outstripping the supply. At some point that will reverse, and I’m sure we’ll see some of these high-flying companies get weeded out.

Even more than valuation concerns, though, is the fact that many of these companies are fundamentally dedicated to one thing: growing and selling marijuana. Marijuana is basically just a commodity. Why is that meaningful? Because a key aspect to a commodity is that it is interchangeable with other commodities of the same time. The marijuana that Tilray grows isn’t significantly differentiated from the marijuana that anybody else could grow in their backyard. Apple (AAPL) and Tesla (TSLA) are interesting investments because people are willing to pay a premium for their products because people perceive them to be noticeably superior. Could any marijuana grower ever make such a claim? I’m not so sure, and that’s why I’m concerned about any of them ever having a durable competitive advantage.

This doesn’t mean that I intend to fully ignore the marijuana legalization trend. There clearly is a huge opportunity in this budding market. For me, the key is to find a way to invest in the trend without overpaying for what would appear to be over-hyped companies. The entire sector seems a little risky right now, so there is currently only one Millenium Falcon sized position in the freedom portfolio that is involved in the marijuana legalization trend.

KushCo Holdings (KSHB) is a company that I first heard about from Motley Fool analyst David Kretzmann that I found to be an interesting way to invest in the marijuana legalization trend without having to worry about to pay sky-high valuations for companies that are essentially simply selling a commodity. Instead of selling marijuana itself, KushCo sells a number of different supplies (such as packaging and vaporizers) related to both the recreational and medical marijuana industry. They have also diversified into the hydrocarbon gas market. Hydrocarbon gases are used in the process of creating cannabis based oils. Essentially, as the trend of marijuana legalization continues across Canada and North America, so should the market opportunity for KushCo Holdings. At the same time, they should be slightly more protected from competition than the cannabis growers themselves.

It’s been an incredibly short time span to the point of being meaningless, but the outperformance so far is better than the alternative and I’ve been encouraged by what appears to be at least slightly less volatility than many of the other marijuana stocks.

P.A.U.L. Score

Protected: 2

As near as I can tell, there’s nothing particularly proprietary about the products that KushCo produces and there’s not much preventing competitors from entering the space. If the market for cannabis (both recreational and medicinal) gets to be as big as many people hope, then competition will increase, which will undoubtedly hurt margins. This is easily my biggest concern with the company going forward. What differentiates them from future and current competitors?

Alternatives: 3

KushCo has already shown a willingness to branch out into different products that are still related to cannabis with their hydrocarbon has expansion. As marijuana legalization continues, it seems inevitable that there will be other types of products that the company could move into as well.

Understanding: 2

To be blunt, I’ve never used marijuana and frankly know very little about how it is used medicinally or recreationally. Is there a market for more accessories once legal cannabis becomes more accepted? I suspect so, but I simply don’t know.

Long Runway: 4

As mentioned a few times, marijuana legalization is in early innings but also seems like an inevitable trend. Take a look at the wikipedia article on the current state of cannabis legalization in the world. There’s a lot of opportunity and a lot of near term catalysts. Canada is preparing to legalize recreational marijuana later this year and more and more US states are moving towards legalization as well. When and if the US federal government finally fully legalizes cannabis, the industry could really see some explosive growth.

Total Score: 11

Not a great score, but that’s why it’s only a Millenium Falcon allocation right now. If it goes to zero, I won’t be out much money, but if it can capitalize on the opportunity in front of it, this could be a company that outperforms the market greatly over the next 5 years.

Disclaimer

Nothing written above is intended to be investing advice and is solely my own opinion. I currently own shares of KSHB and TSLA.