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Know what you own, and know why you own it. - Peter Lynch

Introduction

And so the party continues; all around the country retail investors with dreams of hitting it big in the next emerging industry, pot stocks, continue to pile in and bid up the prices of certain OTC stocks. The names of these companies have been well circulated on boards such as Yahoo Finance and Investors Hub. It has even gotten to a point that certain media outlets like MoneyNews and the New York Post have started to raise awareness and caution potential investors. I've done a couple of articles on these companies already (here and here). I focused on retail investors as my audience and disclosed the inherent risks associated with not just these particular companies, but the OTC market as well. Since then, these stocks have been whipsawed back and forth, and retail investor speculation has only increased. But do retail investors really know what they are buying?

This article will disclose the actual businesses of these companies, highlight the competitive environment in which they operate, and do a comparison of current market value and growth expectations relative to average industry growth rates and values. The companies covered in this article are:

Background

For the most part, retail investors speculating on these stocks have the impression that they are buying into companies that are at the forefront of either the medical or recreational marijuana industry. They believe that as additional states de-criminalize the drug that sales and revenue will skyrocket, justifying the already outrageous market capitalization they have attained. But you may be surprised when you actually find out what business these companies are in, and what kind of competition is actually out there.

As part of our investigation in these stocks, once we identify which industry the company operates (or is planning to enter based on management statements), we can evaluate the company's current value relative to its individual industry using a few assumptions. As a proponent of DuPont Analysis to track companies over a medium to long term (3-10 years), we will use 5 year growth rates, industry average price to sales, and return on assets.

IndustryCapital Goods/ Farm ProductsSpecialty RetailInternet Information providersProcessed and Packaged GoodsPersonal Products
P/S1.80.52.20.81.8
ROA8.4412.0111.667.1513.03
5yr Growth Rate3.189.731.867.413.59

We will make the following assumptions:

  • Industry growth rates will continue at 5 year average
  • Individual company growth rates will compound annually from a market consisting of the populations of Colorado and Washington state, to the entire U.S. Population in 5 years, 19.23%
  • Individual companies will plow back (re-invest) 100% of their sales proceeds into the business over the next 5 years.
  • Assets acquired are efficiently utilized with absolutely no depreciation.

Each of these assumptions is either reasonable (industry growth rates) or extremely generous to each of the companies.

For each company, the analysis will calculate the potential growth rate based on the assumptions above (illustrated by green in each graph) and the potential sales growth required by the company to achieve that growth (illustrated by blue in each graph). Then we will look at current market value of the stock and calculate the growth rate retail investors are speculating (illustrated by red in each graph) and the associated growth in sales that would be needed to achieve that rate (illustrated by purple in each graph). At that point, retail investors can compare current value with a generous valuation based of the assumptions above. That way investors can get an idea of what kind of potential these stock have going forward.

People don't like the idea of thinking long term. Many are desperately seeking short term answers because they have money problems to be solved today. - Robert Kiyosaki

Medical Marijuana, Inc.

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The first company is the hardest for retail investors to wrap their minds around. The company's background reads like a classic shell company model although it claims to never have been one. It is solely a holding company for a portfolio of businesses associated with the hemp industry, and includes brands such as Dixie Botanticals and CanChew gum. It's storied history is well documented and includes a recent lawsuit over the acquisition of Red Dice Holdings and a DTC Chill on the stock that frustrated retail investors for over a year.

Additionally, the company does not (at this time) have anything to do with marijuana. To quote the company, "So that it is clear, MJNA does not grow, sell or distribute marijuana under any circumstances as defined by the USCSA. Red Dice Holdings does sell hemp based products through Dixie Botanicals where these products are legalized and controlled." Obviously, the company has intentions to enter the industry, or wants potential investors to think they will eventually enter the industry. For now, they are limited to the hemp industry and associated cannabinoids.

So, given the plethora of articles and analyst opinions available on this particular company, we will leave the business description here, and look further in the competitive environment.

Because the hemp industry is so broad in nature, the list of competitors is exhaustive. For our purposed, we will consider Dixie Botanicals product like oils, salves and creams and CanChew products such as its chewing gum and non-medicinal edibles. Here is a very small list of relavent competitors:

  • Hemp Traders
  • Living Harvest
  • Nature's Alchemy
  • Jarrow Formulas
  • Nutiva
  • Dastony
  • Manitoba Harvest
  • Natura

So, obviously, Medical Marijuana Inc. does not have a lock on the hemp/cannabinoid market. So, is there reason to believe that the company, just because its shares are publicly traded on the OTC, will rule the consumer botanical market or successfully compete with deep pocketed industrial giants if they ever enter the marijuana industry?

To make sure we cover all bases with this company, we are going to do our analysis twice. Once using data from the personal products industry (oils, salves, and creams) that includes companies like Revlon, Estee Lauder, Physicians Formula Holdings, and Natural Health Trends, and once using data from the processed and packaged goods industry (gums and non-medicinal edibles) that includes companies like Meade Johnson Nutrition, Smart Balance Inc, and Hain Celestial. That way, based on the diverse portfolio of the company, we can assume that it will fall somewhere in between.

As a Personal Products company, our assumptions result in a compound annual growth rate of 22.8% for the company. To attain this overall rate, the company would need to grow sales at an annual rate of 387% per year for the next five years. However, based on the current stock price, the market is assuming an annual compound growth rate of 207%. In order to achieve that, the company would have to grow sales at a 1132% rate.

As a Processed and Packaged Goods company, our assumptions result in a compound annual growth rate of 26.6% for the company. To attain this overall rate, the company would need to grow sales at an annual rate of 1672% per year for the next five years. However, based on the current stock price, the market is assuming an annual compound growth rate of 1339%. In order to achieve that, the company would have to grow sales at a 20,139% rate.

I'm not so certain the sales growth rates the market is currently projecting can be achieved. While MJNA is a well diversified company, expecting compound annual growth rates between 1,000% and 20,000% is unrealistic, and I am unable to fathom any justification for rates that high. Provided the company can mainstream its existing business lines, and since most of their existing business lines are already marketable to the entire US population, moderate growth rates consistent with the industry averages would be more realistic.

If you don't eat yer meat, you can't have any pudding. How can you have any pudding if you don't eat yer meat? - Pink Floyd

Hemp, Inc.

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Hemp, Inc. states that it is focused on the emerging medical marijuana industry. The revenues earned come from sales of botanicals within the broader hemp industry, placing them along side Medical Marijuana, Inc. as a consumer products company. The company states, "The company does not cultivate, distribute or possess marijuana." However, the company has also stated that its intention is to enter the social networking and educational aspect of the industry.

The company contemplates becoming involved in a social networking media via the internet to connect industry participants and serve their information needs. The company also plans to pursue providing a full curriculum to educate participants in the industry both through live seminars as well as via the internet. The company intends to offer industry-related products and services where economically feasible. Finally, the company is developing a website providing entertainment and news which affect industry participants.

Ok, so the door is open to maybe providing medicinal or recreational marijuana products some time in the future (if economically feasible). But for now, the stated objective is to shift from consumer products (hemp based botanicals) to information technology (social networking, news, and entertainment). Perhaps Hemp, Inc. feels the margins associated with their existing business line are not competitive with respect to the list of competitors above. And how serious the company is with respect to this strategy is uncertain. But given the recent press releases, announcements, and spin-out/dividend of the non-traded (as of yet) stock, BioAdaptive, Inc, the company is obviously moving away from the consumer products/botanicals market.

However, the strategy announced by management places them directly in competition with the likes of Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR), not to mention major media distributors. So, is it rational to believe that this company, just because its shares are publicly traded on the OTC, will be able to directly compete with media giants? Or can we expect yet another switch in strategic planning back to consumer products or some other unrelated business line as convenience dictates?

As an Internet and Information Provider company, our assumptions result in a compound annual growth rate of 51.1% for the company. To attain this overall rate, the company would need to grow sales at an annual rate of 195% per year for the next five years. However, based on the current stock price, the market is assuming an annual compound growth rate of 211%. In order to achieve that, the company would have to grow sales at a 569% rate.

Again, I'm not so certain the sales growth rates the market is currently projecting can be achieved. Because the company has made many different changes to its strategic planning over the past year, and because the firm lacks experience and even systems within the internet and information provider sector, I'd consider the baseline scenario overly ambitious and unrealistic.

Make a joke you I will sigh and you will laugh and I will cry - Black Sabbath

GreenGro Technologies, Inc.

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GreenGro Technologies designs, manufactures, and markets vertical cultivation systems. It has also sought to partner with others to lease and develop a farmers market in Buena Park, California, with the intention of building a greenhouse to show and promote its indoor cultivation system. This company has become a favorite on the OTC because many retail investors believe that it will be the leader in providing greenhouse solutions to marijuana farmers. However, the company has less than $5,000 in the bank as of the last quarterly report, had an accumulated deficit of more than $3MM and a net loss of just under $1MM. As a result, the company stated:

While the Company believes in the viability of its strategy to generate revenues and in its ability to raise additional funds, there can be no assurances to that effect. The ability of the Company to continue as a going concern is dependent upon the Company's ability to further implement its business plan and generate revenues.

To make matters worse, any "farmer" that would approach a company with such limited cash resources to produce vertically integrated growing systems could go to:

So, to think that a company that does not have significant working capital could manufacture commercial grade indoor growing systems (greenhouses) and directly compete with the likes of AgraTech, Inc. Atlas Manufacturing, or Poly-Tex is irrational.

As a Processed and Packaged Goods company, our assumptions result in a compound annual growth rate of 28.9% for the company. To attain this overall rate, the company would need to grow sales at an annual rate of 203% per year for the next five years. However, based on the current stock price, the market is assuming an annual compound growth rate of 663%. In order to achieve that, the company would have to grow sales at a 1718% rate.

With this one too, I'm not so certain the sales growth rates the market is currently projecting can be achieved. Provided the company can expand its existing business lines, and successfully launch its farmers market operation, moderate growth rates consistent with the industry averages would be more realistic. However, keep in mind that the market the firm will have will be limited in scope and unable to expand beyond the Buena Park, California area.

What's the frequency, Kenneth? - R.E.M.

Growlife Inc.

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GrowLife, Inc. is another holding company in this space. It has multiple business lines that manufacture and supply gardening equipment and supplies. The company specifically mentions "equipment and expendables for growing of medical marijuana" in their business description. Businesses include SGT, Growlife Hydroponics, Urban Garden, 58Hydro.com, Phototron, Rocky Mountain Hydroponics, Evergreen Garden Centers and Greners, including Greners.com and 58Hydro.com. The company has become a darling of the OTC for the same reasons that GreenGro Tech. above has.

However, similar to our above example, Growlife Inc. has issued a going concern for the business:

For the nine months ended September 30, 2013, the Company incurred a net loss of $4,604,642 and cash used in operations was $1,036,947. The Company has experienced recurring operating losses and negative operating cash flows since inception, and has financed its working capital requirements during this period primarily through the recurring issuance of notes payable and advances from a related party. These facts indicate that there is substantial doubt of the Company's continuation as a going concern.

Now, Growlife has a much larger cash position of almost $200,000 on the balance sheet and more than $1.3MM in revenues. But given the above burn rate and loss, it's no surprise that the company filed a Form D exempt offering of $40MM of warrants. Which begs the question, is it rational to believe that this company, just because its shares are publicly traded on the OTC and it includes the words "medical marijuana" in filings, will be able to directly compete with the same manufacturing companies listed above and not dilute current shareholders?

As a Processed and Packaged Goods company, our assumptions result in a compound annual growth rate of 22.4% for the company. To attain this overall rate, the company would need to grow sales at an annual rate of 122% per year for the next five years. However, based on the current stock price, the market is assuming an annual compound growth rate of 159%. In order to achieve that, the company would have to grow sales at a 377% rate.

And again, I'm not so certain... nevermind, you get the idea. To the company's credit, the portfolio of products being offered are diverse, but to assume the company can successfully compete beyond average industry growth rates is unrealistic. Additionally, since the company already has market exposure throughout the U.S., even the baseline scenario is too generous.

And if the band you're in starts playing different tunes, I'll see you on the dark side of the moon - Pink Floyd

Cannabis Science, Inc.

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The company began as Patriot Holdings, Inc. Then it became National Healthcare Technology, Brighton Oil & Gas, Gulf Onshore, and finally Cannabis Science, Inc. It claims to be on the forefront of medical marijuana research and development. However, given the recent cold snap, many Americans are going to have monthly heating bills that are in excess of the cash this company had in the bank at the last quarter. There are no research and development expenses listed in the last filing, but multiple pages of related third party and equity transactions.

I'd rattle off a list of premium pharmaceutical companies that Cannabis Science is in direct competition with, however, I'm not certain it would be accurate. Since there is no evidence of them "researching" or "developing" anything (at least from a cash flow standpoint) we cannot know who the actual competition, or for that matter, the line of business is.

So, this is one instance where I'm going to guard myself and take Mama's advice. "If you have nothing nice to say, don't say anything at all."

(Analysis? Nope, not going there either.)

Ok people, move along. There's nothing to see here. - Officer Barbrady.

Conclusion

If as a retail investor your intention is to get in on the ground floor of the blossoming recreational or medical marijuana industry, are these really the companies that you should be speculating on? Would it not be more reasonable or responsible to look at the existing tobacco, agricultural, or even the wine/liquor industries or distribution companies that are already in existence and extremely well financed? Or is the simple attraction to these companies the ultra low per share stock price?

If, on the other hand, as a retail investor your intention is to get in on these new exciting companies in differing sectors, are these companies fairly valued based on your expectations? Or would it be more prudent to look at other companies that have an existing market hold and experience?

People might not want to admit it, but the likes of Altria (NYSE:MO), Lorillard (NYSE:LO), Reynolds America (NYSE:RAI), Archer Daniels Midland (NYSE:ADM), or even InBev (NYSE:BUD) have very deep pockets and armies of lawyers. At the drop of a hat they can form and fund a subsidiary that could put your little pink sheet company out of business in short order. And for decades there have been rumors of strategic plans, filed in folders, sitting in executive offices, waiting to be implemented. Are you in this to gamble, or invest?

It's easy to forget sometimes, a share is not a lottery ticket… it's part-ownership of a business. - Peter Lynch

Source: Getting The Dope On These OTC Cannabis Stocks

Additional disclosure: This information is not investment advice, nor is it a suggestion to either buy or sell any of these securities. Retail investors should do their own research and fully understand the risks associated with these companies.