By Michael Johnson
I would like to take a step away from the benefits of medical marijuana, politics of the situation or my personal opinion on the matter and focus on something that is a lot more relevant to your portfolio. The focus of this article today is why investors should stay far away from marijuana stocks.
Price to Sales
Shareholder Value per Employee
Medical Marijuana, Inc.
Cannabis Science, Inc.
Terra Tech Corp.
Source: Yahoo! Finance and EDGAR Search
I recently wrote an article called Tech Bubble 2.0: Overvalued and Undervalued Stocks. In the article I spoke of the bubble I believe exists in Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), LinkedIn (NYSE:LNKD), Pandora (NYSE:P) and Zillow (NASDAQ:Z). I had no idea that I was overlooking a much more obvious bubble inherent in marijuana stocks. Bubbles can typically be categorized by companies trading at unrealistic multiples relative to future growth potential. During the tech bubble, companies were often trading at over 100 times earnings, which is often a characteristic of an overhyped stock. However, marijuana stocks make those multiples look cheap.
Medical Marijuana, Inc. is the largest of the speculative marijuana stocks with a market capitalization of $185.14 million. With a price to sales ratio of 16.30 it appears as if it as about as rationally priced as most other overpriced tech stocks. However, I am a little confused as to how exactly each full-time employee creates $14.09 million in shareholder value. I also have some concerns about the accuracy of their financial statements, which I will address later in the article.
I'm kind of confused how CannaVEST Corp. is a $105 million company and has virtually no online presence. If wasn't for their name I would have a very difficult time figuring out exactly what it is they do. I'm also a little confused as to why Foreclosure Solutions, Inc. (FCLS.OB) has suddenly decided to completely change the direction of their business, but if the new name of the company is a reference to cannabis, it must be a buy! (Please don't take my sarcasm seriously.)
Cannabis Science, Inc. was perhaps a better illustration of an overhyped stock at $0.25 rather than $0.05, but I still cannot justify calling its recent drop a buying opportunity. The company is trading at 1202.71 times sales, with just $33,570 in revenue and a market capitalization of $38.59 million. It is kind of difficult to fathom just exactly how a firm with just two full-time employees is worth that much. Something either doesn't add up or Cannabis Science, Inc. is the world's most productive corporation. I'm going with the former of those two options.
Hemp, Inc. currently trades at 1319.87 times sales and is currently unprofitable. The market currently values the company at $37.68 million dollars, yet the company has 4 full-time employees. I am sure they have a very productive work force at Hemp, Inc., but I have trouble envisioning any possible scenario in which the average employee full time generates $9.42 million in shareholder value.
Why would anyone pay nearly 30 times sales for Terra Tech Corp. when John Deere (NYSE:DE) is trading at 0.92 times sales and sports a modest trailing P/E of 10.88? Not to mention the fact that Terra Tech Corp. is not even a profitable company. If this current trend of growth for medical marijuana and legalization proves to be secular, there is nothing stopping large-cap farm machinery companies from swooping in and letting economies of scale take over.
Growlife, Inc. is perhaps the most rationally priced of the marijuana stocks. However, 16.39 times sales for a company that ultimately manufactures hydroponic equipment is ultimately overpriced. Growlife, Inc. suffers from essentially all the impairments that Terra Tech Corp. suffers from.
THE PUMP AND DUMP
For those of you not familiar with the mechanics of a pump and dump scheme, I suggest you check out this link. The pump and dump is essentially the process of manipulating a micro cap or small cap stock through getting investors hyped up about the company to artificially inflate the price. Buyer A has a bunch of shares of Company XYZ as $0.01. Buyer A then uses his or her network of brokers to create a rumor that Company XYZ has the cure for cancer or is going to be the next multi-billion dollar pharmaceutical company when marijuana is legalized, even though Company XYZ is completely insolvent and reeks of accounting fraud. Of course, this is all illegal, but more often than not pumps and dump schemers are able to avoid prosecution and the more sophisticated schemers can actually execute the pump and dump scheme, without breaking any laws.
Marijuana stocks offer brokers and pump and dump schemers a unique proposition. They can call up unsuspecting victims and try to sell them a product that they are already eager to own. The fundamentals behind the companies may be garbage, but marijuana is a big industry that is going through a major transition in the way the government regulates it. Any half decent broker should be able to turn this story into something people want to buy. Most of the investors buying these stocks are unfamiliar with terms like price to earnings, price to sales, price to book and most of the other key fundamentals, which dictate the performance of a stock in the long run. The level of information disparity between the people manipulating these stocks and the retail investor should be more than enough to keep retail investors away from them, but the hope of getting rich off the Green Rush makes that possibility unlikely.
WHAT YOUR BROKER WON'T TELL YOU
- Federal law supersedes state law. There is nothing stopping Federal regulators from shutting these companies down.
- Agriculture is typically a business for which economies of scale thrive. In the event that marijuana actually does become legal at the federal level, or federal legislation declares that the federal government will not intervene in state decisions, this will open the door for major corporations to implement economies of scale and put most of the small cap marijuana stocks out of business. Say hello to Philip Morris (NYSE:PM) and Altria (NYSE:MO).
- OTC stocks are a breeding ground for accounting fraud. Their financial filings do not have to be audited by an independent auditor and the SEC spends much less time looking for fraud at OTC stocks. I recommend reading the SEC's guide for microcap investors.
- Medical Marijuana, Inc. and Hemp, Inc. do not file regulatory filings with the SEC.
- Michael Llamas, the former CEO of Medical Marijuana, Inc. was involved in a multi-million dollar Ponzi scheme. I am curious to know why a $185 million company has decided to go with a small local accounting firm, Anthony W. Imbimbo, CPA and Associates, rather than one with international recognition, such as one of the Big Four accounting firms. Bernie Madoff decided to stick with Friehling & Associates to audit his firm, even after it had grown to a multi-billion dollar operation, despite the fact that the accounting firm had just one active accountant. Madoff's explanation to investors at the time was that he didn't want a larger firm auditing him, because he was afraid someone would steal his secret formula for success. I wonder what Medical Marijuana, Inc.'s is?
- Most of the companies listed above do not offer audited financial statements.
Stay far away from marijuana stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Capital Traders Group is a team of Proprietary Trading and Equity Research Analysts. This article was written by Michael Johnson, one of our Equity Research Interns. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.