The Secret to Picking the Best Pot Stocks (and Skipping the Lousy Ones)

Right now, we’re in the thick of earnings season – and the lucrative U.S. cannabis industry is right there, too; hundreds of firms across the country are releasing their financial results for Q4 2018.

Now, typically, investors lean on these earnings reports to gain insight into how well a company is run or if it’s performing well.

And for the most part, I agree it’s a great tool…

if you know what to look for.

Frankly, companies know that investors look to these reports to make decisions. So you can bet they are going to present the rosiest possible picture of their financials.

The key is knowing how to look beyond all the smoke and sunshine they’re throwing at you to determine whether the company is worth your hard-earned investment dollars.

That’s why today, I’m going to share the “magic formula” I use when looking through every single cannabis earnings report.

And just to make it really easy, I’m going to boil it down to three things you should look for – and three things you should always ignore…

Don’t Waste Time Looking Through These

There are exceptions to every rule, but generally, you can disregard fourth-quarter revenue.

I know that may sound surprising – revenue is the lifeblood of a company – so I don’t suggest completely ignoring revenue altogether.

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But numbers from Q4 are often meaningless.

For example, Acreage Holdings had revenue in Q4 right around $10.5 million. Looking forward, it’s meaningless.

Adjusting for various acquisitions the company made between Oct. 1 and Dec. 21, revenue would have been more than double that – $22.9 million to be exact.

And even that is too low.

Many dispensaries opened toward the end of the year, and it always takes a few months or even a year to get the stores’ revenue up. That doesn’t matter for a company with hundreds of stores with only a few of them opening in any quarter, but it’s a huge difference for these small, rapidly growing cannabis companies.

Which brings me to the next thing you can safely discount: store counts.

To be sure, a company’s dispensary count is one of the most important metrics of its success as it spreads across the United States. But as investors, we want to be looking forward, not back.

By the end of the year, almost all of the big U.S. multi-state operators (MSOs) will have many more dispensaries than they did back in December, or even right now.

A far more important piece of information to focus on is the company’s build-out plans; that’s a much better indication of where the company you’ve invested in is heading.

Finally, don’t get caught up in the share price right after earnings. That is, unless a stock is being oversold, allowing you to pick up shares at a discount.

A lot of investors trade stocks immediately after an earnings announcement. Some of them have different motives than you do, so keep that in mind if you see a share price wildly fluctuate.

Specifically, a lot of people who have big profits in a stock often set an earnings date to sell some of their shares. All of these people with different motivations and different levels of knowledge mean that stocks of smaller companies, like cannabis companies, often don’t react the way a larger stock might after earnings.

Take Charlotte’s Web Holdings Inc. (CSE: CWEB, OTC: CWBHF), for instance. The stock was down by nearly 2% on the day it announced earnings.

For a bigger company, that would indicate that people were disappointed with the earnings. Here, it was just a little profit taking.

In the trading days since, the stock price climbed more than 20%.

The key takeaway here: Don’t let the knee-jerk reactions of others inform your analysis of a company or its stock.

Now, here’s what you want to look for directly.

I Never Miss These in an Earnings Report

Because some expect the U.S. cannabis industry to eventually be worth $1 trillion, where companies operate and their expansion plans are important information to review during an earnings release.

Some states are better than others for near-term revenue generation, but in the long battle to build a national brand, more states is better.

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Alternatively, a company can have its full focus on a single state, making it an attractive acquisition candidate. If a company is only in two or three states and doesn’t have a clear path to entering more, it’s reasonable to ask the company’s executives whether they see the company as an attractive acquisition candidate, or what the company’s plans are for the day it is surrounded by bigger, better-financed competitors.

The second thing I like to see is cash and the cash burn rate. Most cannabis companies are losing money on an operating basis because they’re spending millions of dollars in capital expenditures.

That’s fine with me, because they’re spending in anticipation of future revenue. In other words, they think that how they’re spending their money now will make them even more money in the future.

Finally, take a look at the projections a cannabis company releases during its earnings.

Many companies don’t offer projections of future revenue or cash flow. But for those that do, well, that’s exactly why most investors are holding them.

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