The joke's on me, it seems.
At the start of the NFL season in September, my fantasy football commissioner suggested we invest our league fees in Canopy Growth Corp., Canada's scorching pot stock, to boost the prize money. The simple calculation behind it: Most of our league managers smoke weed, which suggested many more Canadians do too, so the sector should keep soaring because marijuana is about to be legal.
I was the only team manager against it, arguing pot stock valuations were outrageous because investors were betting almost exclusively based on hype. The prize money could halve, or worse, if the bubble burst.
He listened to me, because I'm a business reporter and we've been buddies since high school. Now, I'm the butt of endless jokes in our group chat. By season end, Canopy's stock had soared 157 per cent. The rub: Our commissioner won the league.
As silly as I looked, I still swear by the same advice. Actually, it's even more apt now.
Perhaps that sounds a little crazy, considering Canopy's market value has more than tripled in four months and the whole sector is on fire in early 2018. Most Canadian marijuana companies were up double-digit percentages on Wednesday alone. Aurora Cannabis Inc. is now worth $6.4-billion, even though its profit for the three months ended Sept. 30 was just $3.5-million.
Yet some chief executives of Canada's marijuana companies are saying practically the same thing. They just have to be a bit more measured with their words.
"What appears to be the case is that the market is valuing companies on total announced production capacity. Period," MedReleaf Corp. chief executive Neil Closner told The Globe and Mail recently. "It doesn't take into account that they may not be able to do it. There's no execution risk being factored in."
Add Newstrike Resources Ltd. CEO Jay Wilgar to the chorus: "You never hear a beer company brag about how they have 800,000 acres of barley fields," he said. "That is not how it works."
Execution sounds like a pretty boring concept, to be honest. But study enough companies and it emerges as one of the defining features of success or failure over a full business cycle.
Even the most reputable companies can suffer from execution woes. Lululemon Athletica Inc. got battered when some of its famous skin-tight pants proved to be a bit see-through; Barrick Gold Corp. promised investors it could build a state-of-the-art gold mine high in the Andes Mountains, then wrote off $6-billion on the project.
Somehow startup cannabis companies, some with virtually no history – or profit – are supposed to be infallible?
The investors behind this hysteria aren't necessarily rational buyers, either. Bruce Linton, Canopy's CEO, laid it pretty bare in Report on Business magazine last spring, back when his company was worth nearly $2-billion. (It's now worth more than three times that.) He spent years desperately trying to raise money to get Canopy up and running, but struggled. Then the junior commodity market tanked and investors started lining up. Come 2014, "I had to beat them away with a stick."
The junior mining market, especially, was full of speculators. An investment banker who financed many of its companies used to tell a good joke. "What do you call a junior mining CEO standing on top of a pile of dirt?" The answer: "A liar." The sector was rife with rumours, fuelled by newsletters and online message boards whose writers would occasionally claim to have inside information.
That money is now chasing marijuana.
Psychological issues are likely skewing investors, too – whether they know it or not. It can be excruciating to sit on the sidelines when you think your friends are getting rich without you.
It's hard to tell when the shakeout will come – or what will spark it. Sometimes a single company gets loose with its financials, the way Poseidon Concepts did during the energy boom, then investors start to cash out and take their profits off the table. Sometimes simple economics does the trick. In most commodity booms – and marijuana is a commodity, remember – there ends up being way too much supply, relative to demand.
Or it could be that sophisticated short sellers, who profit when stock prices fall, try to capitalize on the hysteria and launch campaigns to discredit Canada's pot company valuations. It almost always happens when a sector gets hot. On Wednesday, Citron Research took aim at Aurora Cannabis, arguing that the company has "no path to profitability."
Could pot stocks keep climbing from here? Certainly. Junior resource companies soared for years, and they made a lot of people rich.
But then they tanked. Fast. The TSX Venture Exchange, where most junior resource companies get traded, soared to nearly 2,500 in 2010, then crashed and lost more than three quarters of its value. Even asset manager Eric Sprott, who bet heavily on gold and silver and produced stunning returns for years, got burned.
Anyone desperate to invest in pot stocks should ask themselves two questions.
The first: How much risk is worth it? An investor could double her money in marijuana, but she could lose half of it. Meanwhile, I bought more of a boring Canadian bank exchange-traded fund last August, and I'm already up 11 per cent, before dividends. I'll take that return over pot speculation any day.
The second: What size return will be enough? Is 50 per cent in six months decent, or will the ride become addictive? Humans are greedy animals who almost always want more. It's one of our biggest flaws, and it's one of the reasons we're prone to buying hype – and getting burned.