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Summary

  • Growlife investors are exposed to risks even if legal matters does not directly affect Growlife.
  • There are no guarantees the next President will support marijuana.
  • Investors should note potential dilution.
  • Growlife's management is honest and transparent in addressing their risks.
  • Growlife's revenue is growing fast but so are their expenses.

When investing in volatile industries and especially specific stocks like Growlife (OTC:PHOT), it is best to investigate your risks. While rewards can be high, risks must be thoroughly assessed to make the best decisions for your portfolio. These are some of the most common assumptions I see about PHOT from investors.

1. PHOT bears little legal risks compared to other marijuana stocks.

While that is true, those legal risks actually affect share prices. The current legal conflict between state and federal law may not affect PHOT's business because it doesn't sell the marijuana itself. However, it does affect PHOT's shareholders since it will cause share prices to fall if potential events occurred.

What some investors don't acknowledge is that risks to shareholders are not the same as risks to businesses. The main risk shareholders care about is the volatility of share prices. PHOT is labeled as a marijuana stock and any major legal problem. When any legal problems with the law that could hurt the potential sales of marijuana for the industry as a whole, then PHOT stocks will fall with the rest. The legal risks also spread over to PHOT's ability to find financing. We know that most banks refused to lend to any marijuana businesses due its illegal status under federal law.

PHOT acknowledged these risks in their 10K filing.

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2. The Obama Administration and DOJ have agreed not prosecute anyone or any business if they follow state laws.

While that is true, the Obama Administration will start packing its bags in two years. Eric Holder of the DOJ is not guaranteed to remain in his position forever. This is a risk that shareholders have to acknowledge since support from the next administration is not guaranteed.

I believe the marijuana movement will eventually win and become legalized. However, that may not come for the next two presidential terms depending on who is elected and appointed in various offices. A delay in legalization or support of 4 to 8 years is possible, and can adversely affect all marijuana stocks including PHOT.

The only real assurance marijuana related industries will boom in the next 10 years is if the laws support it. There is currently no support from federal laws for marijuana, not even for medical purposes. That's a fact.

3. PHOT's revenue is rapidly growing and it will be worth much more in a few years than it does now.

That assumption is probably right. However, that does not mean investors will actually gain from it. Take a look at the rapid dilution happening with the stocks. Let's look at YoY results first.

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PHOT's 2012 weighted average shares outstanding were 245M in 2012 and 593M in 2013. With that kind of dilution, each share is effectively worth less than half if market cap remained the same. PHOT may be worth more in market cap but it does not necessarily mean an individual investor will see their investment appreciate.

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Let's analyze 2013 progressive dilution. 2013 had an average of 593M outstanding shares. If you look at its QoQ results you'll see it went from 443M on Mar 31st to 722M by Dec 31st. That's an aggressive growth of outstanding shares.

PHOT will be forced to continue issuing shares to pay for its acquisitions, expenses and executives. They don't have much of a choice when they are short on cash and resources. It's difficult for any marijuana business to get financing at the present time. You see plenty shares being issued throughout the year in their 10k, like these.

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They also warned investors about these potential problems. I appreciate the fact that PHOT is upfront and honest about their risks. This speaks volumes about their management and transparency. You can find this in their 10k as well.

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PHOT's revenue is rapidly growing but it's still not profitable by any means. The 10k showed their revenue is up from $1.4M in 2012 to $4.8M in 2013. That's amazing growth by any standard. However, their net loss went from $2.1M to $21.3M in the same period. Their net loss per share is 4 cents. That's very high since the current share price is only 12 cents.

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The trend for net loss is going up if you look QoQ from Q1 to Q4 of 2013. However, I believe PHOT's management will eventually solve their profitability problem. These folks are executives and experts from much bigger organizations. However, it may not be any time soon. The real question is how and where will PHOT's management continue to fund their operations. Would it be from further dilution or more debt?

I also appreciate PHOT's management in being transparent about their profitability and accelerating expenses. There's hope when management is acknowledging the problem and actively trying to find ways to fix it.

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Taking a look at PHOT's balance sheet, there's some things to note. The basics of account is:

Assets = Liabilities + Equity

Usually, liabilities is lower than assets. This is because if you had more liabilities than assets, then equity must be negative. Basically, their net worth is negative on the balance sheet.

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Source: Yahoo Finance

In the past 3 years, PHOT's liabilities have been higher much than their assets. I believe they can eventually reverse this trend when their sales pick up. However, their expenses continue to grow along with their income YoY. This balance sheet will get substantially better, but it probably won't be this year. The revenue projection for 2014 is $10M which is more than double the revenue for 2013. However, PHOT is honest in warning investors that there's no way to accurately project revenue with certainty. I appreciate their honesty because they know the current volatile nature of this industry at the present time.

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Conclusion

From everything I've gathered, PHOT is definitely a high risk stock. The remaining factor being how high is the reward. That's something investors have to figure out on their own since every estimate is bound to be very speculative by nature. Nobody knows which state will legalize marijuana next and to what extent. Nobody knows what the next President and administration will support.

I don't view PHOT having as high of a reward as another marijuana stock like Terra Tech (OTCQB:TRTC). The main reason is that PHOT isn't planning on growing marijuana. Growing marijuana is a high revenue business if you can make it happen. At the same time, PHOT will bear most of the same risks to its shareholders. Legal matters may not directly affect PHOT, but it will definitely affect share prices. The reasoning is simple. If growers are facing prosecution, then how much sales would PHOT have? PHOT stocks will fall with the rest of the industry when such adverse events happen. That is a risk to investors.

Looking at balance sheets and income statements, Terra Tech is in a much better position.

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Source: Yahoo Finance

TRTC's balance sheet is actually in the positive for equity. That's an encouraging sign when so many other marijuana stocks are in the negative.

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Source: Yahoo Finance

TRTC's income statement shows high growth in revenue YoY while losses remained roughly the same level. That's a much better trend than PHOT's increasing losses.

In my opinion, if you are debating between PHOT or TRTC, then TRTC is a clear winner. Not that I know which stock will perform better. TRTC's current situation is better and they plan on growing marijuana. They have high potential rewards to go with their high risks. Currently, TRTC is at a lower market cap than PHOT as well.

As for me personally, I wouldn't invest in either. Canada federal law allows marijuana growers to grow legally. I would rather invest in companies that pursue legal markets rather than illegal ones. It's less risky overall.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Source: Growlife Inc.: 3 Assumptions To Rethink