The pot industry is among the fastest growing industries in North America. According to estimates from ArcView, a leading cannabis research firm, the North American legal pot market is expected to grow by 26% per year through 2021. If this estimate proves accurate, investors will be seeing green to the tune of almost $22 billion in annual sales in three years. That's really what the buzz is all about.
However, we also can't overlook just how much the public's perception of pot has changed over the years. National pollster Gallup, which has conducted surveys for 48 years on marijuana, found in its latest poll (Oct. 2017) that nearly two-thirds of the public favors legalizing pot. Medicinal cannabis has even higher favorability, according to a survey from the independent Quinnipiac University this past August. In that poll, 94% demonstrated support legalizing medical cannabis, compared to a minuscule 4% who opposed such a measure.
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Pot stock investors must choose wisely
Despite this momentum, not all countries are created equally when it comes to investing in pot stocks. For example, even though Americans might be for the legalization of medical and recreational weed, the federal government still classifies it as a schedule I substance. In short, it means pot is entirely illegal, and that it has no recognized medical benefits. Add this to the recent rescinding of the Cole memo by Attorney General Jeff Sessions – the Cole memo was a loose set of "rules" that legalized states agreed to abide by in order to keep the government off their backs – and the U.S. market is downright anti-cannabis.
On the other hand, Canada has blossomed into a high-growth country for the pot industry. That's because Canada might become the first developed country in the world to legalize recreational weed this July. Progressives are firmly in control of the Canadian parliament, and the federal government and provinces have already worked out a tax-sharing agreement, putting a major hurdle in the rearview mirror. Added to an already successful, and growing, legal medical cannabis industry overseen by Health Canada, and it's easy to see why Canadian pot stocks have flourished.
The top pot stocks to consider buying
If you're looking to get your feet wet by investing in this high-growth industry, the two best pot stocks to consider buying both hail from Canada. However, as you'll see below, there's also a Canadian pot stock that you're best off avoiding.
Admittedly, Aphria (NASDAQOTH: APHQF) has already had an incredible run. Over the trailing two-year period, its share price has gained just over 2,000% as medical sales have expanded and Canada inches closer to legalizing adult-use pot. Some folks would suggest that it's fully valued at this point. I'd disagree.
Aphria has two major projects working in its favor. First, it's undertaken a four-phase capacity expansion that's costing it in excess of $100 million. When complete in late Jan. 2019, this project will have increased Aphria's growing capacity to 1 million square feet, which it believes will yield in the neighborhood of 100,000 kilograms of dried cannabis a year.
Additionally, earlier this month Aphria announced a strategic relationship with Double Diamond Farms that it anticipates will yield 120,000 kilograms of dried cannabis by Jan. 2019, assuming licensing approval. Aphria had been planning to build out its 100-acre site to double its yield, but this newly announced partnership will allow that doubling in production to occur a year ahead of schedule. And make no mistake about it, there very well could be first-to-market advantages for the major pot producers if Canada continues moving forward with efforts to legalize adult-use weed.
The intangible aspect about Aphria that investors should appreciate is its management team. Whereas quite a few of its peers are expanding with absolutely zero regard to profitability, Aphria prides itself on generating positive EBITDA (earnings before interest, taxes, depreciation, and amortization), which it's done in each of the past nine quarters, on an adjusted basis. It's also been profitable on a full-year basis in each of the past two years. It's certainly worth a look for opportunistic pot stock investors.
Cannabis Wheaton Income Corp.
One of the best pot stocks to consider adding to your portfolio is probably one that's flown completely under most investors' radars: Cannabis Wheaton Income Corp. (NASDAQOTH: CBWTF). Unlike traditional growers, Cannabis Wheaton is a royalty company, which comes with a list of benefits.
In simple terms, rather than handling the day-to-day operations of growing pot, Cannabis Wheaton acts as a lender to help budding companies get their grow operations or distribution off the ground. In return for the capital that allows this to happen, Cannabis Wheaton receives a percentage of the production. It's able to buy this pot at well below market prices, and then turn around and sell it at market price, thusly pocketing the difference. Not surprisingly, it gets its names from Wheaton Precious Metals, the royalty company that has the same exact business model, save for precious metals.
The result of this lucrative business model is that Cannabis Wheaton should have the highest margins among all pot stocksi, and is expecting an internal rate of return of 60% with an average deal. Estimates from the company show a cost of goods sold per gram of around $2, compared to an average selling price of around $6.20 per gram. That's a coincidentally hilarious EBITDA of around $4.20 per gram sold ("420" being the term in cannabis culture referring to pot consumption).
The royalty model is also flush with diversification. Cannabis Wheaton has around 15 production deals on its books that are expected to yield a combined 230,000 kilograms of dried cannabis a year by 2019, assuming every one of its partners stays on track. If one or two of these deals doesn't pan out, it doesn't mean the Cannabis Wheaton ship sinks. Instead, pot stock investors get the opportunity with a company like this to buy into geographic and production-based diversification.
And one pot stock to avoid...
However, blindly buying into pot stocks wouldn't be a good idea – not even in Canada. One strikingly popular pot stock I'd suggest you consider avoiding is Aurora Cannabis (NASDAQOTH: ACBFF).
Now don't get me wrong, Aurora Cannabis is doing a lot of things right. It's in the process of constructing its flagship facility, the Aurora Sky. When complete in mid-2018, this highly automated facility will span about 800,000 square feet and be capable of more than 100,000 kilograms of dried cannabis production each year at a very low cost.
Aurora is also actively engaged in expanding its production capacity through partnerships and acquisitions. Back in November, Aurora launched an unsolicited bid, which became a hostile bid, for CanniMed Therapeutics. Just days ago, CanniMed agreed to a $1 billion cash-and stock deal to be acquired. Aurora should realize cost-saving synergies through this acquisition, and it foresees the ability to produce in excess of 130,000 kilograms of pot per year as a single entity.
What should give investors pause with Aurora Cannabis is the company's incessant dilution of its shareholders via bought-deal offerings. Whether its common stock, warrants, options, or convertible debentures, bought-deal offerings – a sale of stock or debt to an investor prior to the release of a prospectus – result in the inevitable increase in a company's outstanding share count. Since mid-2014, Aurora's share count has ballooned by more than 2,200% to 375 million shares. Mind you, this doesn't count over $250 million in bought-deal financing since the end of its fiscal first quarter, or the conversion of the remaining balance of an outstanding debenture totaling $60 million in mid-Novmber 2017.
In other words, even as Aurora's business thrives, its share price could suffer because of massive dilution, hurting pot stock investors in the process.
This article originally appeared on The Motley Fool.