Marijuana Business Magazine | May-June 2020 20 Cannabis and the Stock Market Correction InvestorIntelligenceSnapshot | Stock Market Correction By Craig Behnke and Mike Regan A s of April 7, the large capitalization S&P 500 Index was 21% off its Feb. 19 high, while the average cannabis stock tracked by Marijuana Business Daily was down 76% from its 52-week high. The upside is that cannabis companies were, on average, up 32% from lows reached in mid-March. What does this all mean for cannabis investors and executives? There is a big difference between the performance of cannabis stocks and the underlying cannabis businesses . While strong operating performance usually leads to higher multiples and stock prices, this is not always the case—especially when an external shock to the markets (such as the international outbreak of COVID-19) leads to rapidly declining multiples that account for higher risk. While the underlying business might be fine, valuation multiples ascribed to a company will decline as broader market multiples decline. Cash-Generating Businesses Can Ignore Short-Term Capital Market Volatility While private-market valuations are informed by the public market, a company that generates cash need not rely on the financial markets for survival. A business generating cash gives its owners the freedom to reinvest that money or wait for financial markets to ascribe a higher valuation. In the initial land-grab phase of the marijuana industry, the true business model of many companies was to profitably sell their cannabis companies rather than cannabis itself. This model won’t work in the current environment. Investors need to see a path to profitability and will no longer invest based on the assumption that someone else will pay more for the footprint in the future. Advice for Investors and Companies • Look for opportunities amid the declines. The same businesses are now cheaper, while the long-term opportunity has not changed. • Ask yourself: What is the true source of this investment’s return?Will the business generate $1 million of cash profit per year selling cannabis, or are you hoping that someone buys the company for $20 million? The former lets you control your destiny; the latter relies entirely on hope—and hope is not a strategy. • Look for companies with profitable divisions—even if the overall business is unprofitable—to focus on shifting the loss-makers to profitability or shut them down. Seeing at least some profit lets investors value the current profit separately from the future opportunity. • Analyze supply chains. Your company or investment might be well run, but it could still suffer if its own suppliers or customers run into problems. A recent example is when MedMen Enterprises started paying suppliers with equity instead of cash in January. That equity has since declined 60% in value. Source: FactSet financial data and Investor Intelligence estimates. Average Percent Return From 1-Year High 1-Year Low U.S.-Focused Vertically Integrated Operators -78% 21% Canada-Focused Vertically Integrated Operators -84% 36% Hemp & CBD -88% 43% Pharmaceutical -50% 24% Ancillary Services -69% 37% S&P 500 Index -21% 19% Average Return of Public Stocks on the Investor Intelligence Comp Table Mike Regan is an equity research analyst for Investor Intelligence. Craig Behnke is an equity research analyst for Investor Intelligence.