Part of cannabis and investing
If you’re wondering how to invest in Canada’s nascent marijuana sector, following the professional recommendations of financial analysts must look like a good place to start.
Unfortunately, these recommendations can be laughably inaccurate – too often analysts encourage investors to buy shares when they should be selling, and hold shares when they should be buying − reflecting not only the volatile nature of the marijuana sector but also the challenges of pegging value on stocks that resist traditional valuations.
Cormark Securities downgraded its coverage of Aphria Inc. in Dec. 2017, after the shares had surged nearly 1,500 per cent over the previous two years.
An incoming analyst, replacing the previous analyst who had a “buy” recommendation on the stock during its remarkable rise, was unenthusiastic about Aphria at these lofty heights. He began with a “market perform” recommendation, which is the equivalent of “hold.”
The same analyst then changed his tune. In January, he upgraded his recommendation to “speculative buy” – let’s just call that a “buy” recommendation − and boosted his target price by a whopping $9 a share. Unfortunately, the share price didn’t play along with the upgrade: It has since slumped 52 per cent.
While this is a particularly egregious example, it is not an uncommon one.
The Globe looked at 26 analyst recommendations by five brokerages for six marijuana stocks, which is a wide sample of the overall coverage of the marijuana sector. We graded the results based on whether the calls made money, lost money, missed rallies or avoided declines.
Nearly half of the calls (12 of 26) received letter grades of C or lower, meaning that the call either lost money or missed rallies. This dismal performance implies that analyst recommendations aren’t providing much assistance: Investors could simply flip a coin.
Canada’s marijuana sector is striving for acceptance by sophisticated long-term investors, and coverage by financial analysts is a step toward respectability. Apart from Cormark, the sector has attracted analysis by Beacon Securities, Echelon Wealth Partners, GMP Securities and Canaccord Genuity.
This week, BMO Nesbitt Burns became the first bank-owned brokerage to begin covering the marijuana sector.
However, given the sector’s short track-record, the federal government’s new regulations for marijuana use and the fact that companies are not yet generating meaningful profits, typical valuations don’t apply.
This may explain why analyst target prices and recommendations jump all over the place.
Last week, Beacon Securities upgraded its recommendation on Canopy Growth Corp. to “buy” from “hold” – and bumped up its target price on the stock by 50 per cent.
The analyst’s new-found enthusiasm is based on his recent tour of Canopy’s B.C. greenhouses, which the analyst believes will generate 150,000 kg of cannabis in 2020, after recreational marijuana use is legalized.
“Canopy is the go-to name for investors in the sector today,” the analyst said in a note. “We are already seeing the company benefit from a ‘flight to quality’ during the recent shakeout, and we believe the current pullback represents a good entry point.”
But his new price target is based largely on sales volume and marijuana pricing two to five years away – a scenario that is vulnerable to changes as marijuana producers battle for market share in the years ahead.
Perhaps this is why the Beacon analyst has already shifted his opinion on Canopy since starting his coverage in December, 2016. His initial “buy” recommendation worked out well for anyone who followed it: The share price doubled within a year.
His shift to a “hold” recommendation in November, 2017, didn’t work out though: Anyone who followed this new line of reasoning, and didn’t buy the stock, missed out on a subsequent 40-per-cent gain. And since the analyst shifted back to a “buy” recommendation last week, the share price has fallen 3 per cent.
To be sure, some analysts’ calls have been more successful.
GMP’s recommendations for Canopy, Aurora and MedReleaf resulted in four As, a D and a C, according to our scoring, which stands out from the others. His “buy” recommendations preceded gains ranging from 65 per cent to 300 per cent, although his “hold” recommendations have not been successful because they missed subsequent rallies.
And Canaccord’s recommendations on Aurora have been downright superb. The analyst recommended the stock as a “buy” in February, 2016. After the stock had rallied more than 400 per cent, he downgraded his recommendation to “hold” in March, 2018 – potentially saving investors from a 30-per-cent decline if they didn’t buy the stock.
But, given the overall inaccuracy of recommendations, it is nearly impossible for investors to know which opinion to follow, on which stock, and when.
Compounding the problem is the fact that the marijuana sector is prone to large shifts in investor sentiment. Day-trading is rampant, reflected in tremendous trading volumes, and this is contributing to volatility in the sector. The big rallies and selloffs can sometimes leave analysts’ calls looking antiquated.
Canaccord started covering MariCann Group Inc. in July, 2017, with a “speculative buy” recommendation when the shares traded at $1.41. The analyst hasn’t changed that view, and the shares have since risen 7 per cent, which is good enough for a B in our scoring.
But this only tells part of the story. The analyst reiterated his “buy” recommendation in January, when the shares traded at $3.88. Anyone who bought at this peak has endured a 60-per-cent decline in the share price.
Canaccord’s coverage of Canopy has been troubled as well. The analyst began with a “hold” recommendation in March, 2017, when Canopy shares traded at just $11.30. But after several “hold” reiterations since then – and a brief “sell” recommendation – the shares have risen 135 per cent. Anyone who followed this opinion lost out.
Perhaps the analyst feels some pressure to turn bullish on Canopy now that the stock has risen so much. Be careful if he does.
Editor’s note: This article previously stated that Cormark’s coverage of Aphria began in 2017 with a “hold” recommendation. However, this refers only to the current analyst; a different Cormark analyst began coverage of Aphria in 2016 with a “buy” recommendation, which was exceptionally profitable and would be worthy of an “A” grade.