Unfortunately, many new investors/traders all-too-often equate share price to determine whether a stock is "cheap" or "expensive." For example, if you ask the typical average Joe whether Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG) is worth more, he may be tempted to pick Google as its share price is nearly double that of Apple. In reality, when buying stocks, it is imperative that investors don't think in terms of the price of an individual share, but instead in terms of the whole business.
The "Buying The Business" Mentality
When I go to purchase shares of a company, the very first thing I look at is the market capitalization. Outside a couple of extreme cases, it is going to be very difficult to see outsized returns from a company with a $100B+ market capitalization. Conversely, something with a fairly small market capitalization - say $300mm - is much more likely to double or triple, as the underlying business may have significant room to run.
But raw market capitalization isn't enough either - you have to try to figure out what a company is worth by figuring out how much the company can earn per share over your investment horizon. Ultimately, by buying stock, you are buying the future cash flows of the underlying company.
Medical Marijuana Is Not Cheap
Medical Marijuana (OTCPK:MJNA) is a penny stock that seems to have investors excited. Right now, shares trade at $0.27/share, which is what seems to entice many of the newer retail investors to the name. Many think that the stock is "cheap" because each individual share is cheap, but in reality we are looking at a company with a $218M market capitalization. Further, we note that each share trades at 67x earnings, which means that for your $0.27 investment, you are entitled to a mere $0.004.
Now, high multiples aren't unreasonable for high growth situations, and the company is certainly trying to sell itself as a high double digit growth story that piggybacks itself on the continuing legalization/acceptance of medical marijuana products across the United States. However, the problems with such an incredibly high multiple for this particular name are numerous:
- Unreliable Financials: Doesn't it seem awfully strange to anybody that the company has made very "hand wavey" projections about its future cash flows? Further, it is widely suspected that its "cash flows" and "earnings" are largely a result of continued mass dilution of shares, since the share count continues to balloon. The financials are far from audited, and it remains to be seen if they ever become so.
- Lack of Visibility: Generally speaking, a multiple in the 60's typically means that not only is the growth expected to rage on unabated for years to come, but that it is sustainable and not particularly threatened. Even if the bulls get their ultimate thesis that medical marijuana becomes legal everywhere, Medical Marijuana doesn't really have much of a "moat." True to basic economics, suppliers of these very low barrier-to-entry products will flood the market and could very likely induce severe pricing/margin pressure.
- Bubble-Like Hysteria: Another big issue is that I believe that this stock is a playground for retail investors, many of whom have fairly limited knowledge of investing principles. It is a "hot penny stock" that has to do with "marijuana," so many likely feel that it's right to buy in because they think marijuana should be legal. Eventually, this will fade and the stock will see a dramatic drop as it trades for more reasonable multiples.
- Questionable Management: Management explicitly took the time to mention the article published by Infitialis on this name and to claim that they would "pursue legal action." Not only did this severely damage management's credibility - as Infitialis took care to cite their sources and took down wrong information immediately - but it seems to me that by making such a big deal about it and trying to threaten Infitialis with "legal action," the company is too much on the defensive. I do not believe any legal action will be pursued, as I believe that a number of the accounting anomalies, coupled with the potentially illegal share dilution (as per Infitialis' research) is not something the company wants to be made public.
In short, with hazy growth estimates, non-audited financials, management that became far too defensive over a Seeking Alpha article (that cited its sources and was cleaned up quickly from any inaccuracies), all with a questionable increase in share count, I would stay far away from this name. There's not enough potential reward to short it (although I do believe it will go to $0), but staying away could be the healthiest thing for your portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.