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Are Cannabis Stocks Undervalued?

Cannabis stocks perked up at the end of last year before giving back those gains on a lack of federal action. Are cannabis stocks now undervalued?

Cannabis Leaf

Quality cannabis stocks are sure starting to look undervalued, trading at just one to two times sales. Yet their end markets are growing at 10-13% a year. And in many cases, company sales are growing much faster.

Does this make any sense to you? It doesn’t make any sense to me.

What explains the disconnect? Once burned, twice shy. Late last year investors got overly enthusiastic about potential favorable banking reform at the federal level. Politicians came up short and it didn’t happen. Traders and investors got out, and everyone in the space took a serious drubbing. Cannabis names fell by 30%-40% in a hurry late last year.

After that kind of damage, even hardcore cannabis investing enthusiasts now have a difficult time being bullish. That’s a lot of pain. Outsiders looking at the space see that kind of damage and take a pass, concluding it’s too risky.

In short, sentiment on the space is extremely dark. But that’s the time you want to consider buying a group – especially when several bullish trends remain in place (more below) despite cannabis names being undervalued.

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Granted, few people expect any positive action at the federal level soon, now that Republicans control the House of Representatives. Polls consistently show that conservatives, particularly older ones, are the least likely to favor cannabis legalization. Over half of them do, but barely half.

Overall, though, a substantial number of voters favor cannabis reform including legalization. A late December survey by Data for Progress found 65% of Americans favor cannabis legalization. “Our poll shows that voters are ready for the U.S. government to finally legalize the adult use of recreational marijuana,” said the self-described progressive think tank. These findings confirm other cannabis opinion polls.

The upshot here is that state-level politicians continue to respond to voters by working toward legalization. New York, Connecticut, Rhode Island and Missouri are opening up the market for legal sales of cannabis for recreational use right now. Maryland will join them later this year. Minnesota is likely to approve legalization of recreational use sales this year, and serious legalization efforts are underway in at least a half a dozen other states.

The legalization trend explains the robust sales growth. Two companies in our portfolio recently reported 43% and 24% year-over-year sales growth. They won’t be the last of our names to reveal this kind of growth, as earnings season unfolds in the coming weeks.

Here’s why. The research group BDSA is projecting 13% global compound annual sales growth globally to $57 billion in 2026 from $30 billion in 2021, in a low-growth economy. That’s big. “There are a lot of markets, other commodities and other industries that would love to see 13% year-over-year growth,” said Organigram (OGI) CEO Beena Goldenberg in her company’s January earnings call. “I think the consumers are going to continue to come.” State-level data bear this out. We recently saw reports of sales growth in the 6%-10% range sequentially (month over month) and over 30% year over year.

And who knows, even at the federal level we might see a positive surprise. Many investors now view last October’s hoopla about favorable federal reform as mere opportunistic election hype from politicians looking to garner votes. These skeptics believe we won’t see a repeat of this until the late summer of 2024 when another election looms.

That might be the case. But maybe not. Rep. Nancy Mace (R-SC) reaffirmed her efforts to convince more fellow Republicans to support cannabis reform, in an appearance last week on Real Time with Bill Maher. “Republicans have been on the wrong side of cannabis,” said Mace. She also reiterated her intention to win approval of her States Reform Act. The bill seeks to remove cannabis from Schedule I classification, which would help the sector a lot.

The presence of a high-profile House conservative like Mace lobbying fellow Republicans to support cannabis reform increases the odds of approval of other favorable measures, like changes that would allow more banks to serve cannabis companies.

The bottom line: Federal level reform is still the wild card. But cannabis stocks look undervalued, maybe downright cheap. And bullish state-level reform marches on. That will continue to expand markets and justify bullish forecasts, like the 13% growth expectation from BDSA. You might have to be patient to see returns, but the setup seems bullish for cannabis names – given the dismal sentiment combined with the positive trends.

To learn more about how to invest in cannabis stocks, click here for your free report. To see which cannabis names we like best, subscribe to Cabot SX Cannabis Advisor today!

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Michael Brush is an award-winning Manhattan-based financial writer who writes a stock market column for MarketWatch. He is editor of Brush Up on Stocks, an investment newsletter. Brush previously covered the stock market, business and economics for the New York Times, the Economist Group, MSN Money, and Money magazine.