2 Reasons Weed Stock Profits Will Continue to Disappoint in the Short Term

Cannabis stocks like Canopy Growth Corp (TSX:WEED)(NYSE:CGC) are doing well this year. But with scant earnings, can they possibly keep it up?

| More on:

It’s just a few days until pot becomes legal, and the question on everyone’s mind is, “How high can cannabis stocks go?”

As the late summer rally showed us, cannabis stocks can go pretty high — like, $15 billion market cap high. But with most cannabis stocks cooling off in the past few weeks, we can see clearly that no rally is forever.

One of the culprits behind the cooling off’ we’ve seen in cannabis stocks recently is the profitability question. Put simply, very few cannabis companies are actually profitable in net income terms. If we exclude unrealized investment gains from the equation, almost none of them are. While the profitability issues in the cannabis sector mainly come from high investment costs that will presumably taper off at some point, it remains to be seen how profitable these companies will be when the earnings floodgates finally burst open.

Many are hoping that legalization will be the “saviour” of the cannabis industry that finally makes pot stocks profitable after years of growing losses. While this is certainly possible, I wouldn’t count on it. To understand why, we need to look at the cannabis industry as a whole.

A competitive landscape

The Canadian cannabis industry is a competitive space. There are over half a dozen publicly traded cannabis companies in Canada, all of them competing for the same recreational cannabis supply contracts and prescription cannabis sales. While these companies can differentiate themselves somewhat with their international strategies, on the domestic front they are basically interchangeable commodity suppliers.

This means that, in the long run, these companies are likely to start competing on price points, as happened in Colorado when cannabis was legalized there. Add into the equation even more price pressure from black market vendors, who will cut prices to remain relevant in the legal cannabis era, and you’ve got a recipe for falling prices.

Spiraling costs

While I think it’s likely that pot prices will fall when cannabis becomes legal this week, it’s not inevitable. What is inevitable is many cannabis companies’ expenses continuing to grow for the foreseeable future.

Take Canopy Growth (TSX:WEED)(NYSE:CGC) for example. Canopy wants to be the number one cannabis producer in all of the 11 international markets it operates in. This will require massive infrastructure investments, which the company is financing largely from the proceeds of the Constellation Brands deal.

The infrastructure involved in building up a globally dominant cannabis company is substantial, with grow sites, transportation, and storage infrastructure being only the tip of the iceberg. In order to become consistently profitable, Canopy will need to earn a significantly positive ROI on all of these infrastructure investments — and it’s not guaranteed that they will. Sudden government action against cannabis in any of the countries Canopy is investing in could make some of the company’s investments go to naught. For these and other reasons, pot companies like Canopy may have a rocky road to profitability ahead of them.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned.

More on Investing

The virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.
Tech Stocks

Emerging Canadian AI Companies With Big Potential

These tech stocks are paving the way to an AI-filled future, but still offer enough growth ahead for a strong…

Read more »

Young Boy with Jet Pack Dreams of Flying
Tech Stocks

Is Constellation Software Stock a Buy, Sell, or Hold for 2025?

CSU stock has long been a strong option for high growth, high value stocks. But are there now too many…

Read more »

rising arrow with flames
Investing

2 Riskier Stocks With High Potential for Canadian Investors in November

Risky stocks such as Well Health Technologies have the potential to provide life-changing long-term returns.

Read more »

hand stacks coins
Dividend Stocks

3 Ultra-High-Yield Dividend Stocks You Can Buy and Hold for a Decade

These three high-yield dividend stocks still have some work to do, but each are in steady areas that are only…

Read more »

senior man and woman stretch their legs on yoga mats outside
Dividend Stocks

TFSA: 2 Canadian Stocks to Buy and Hold Forever

Here are 2 TFSA-worthy Canadian stocks. Which one is a good buy for your TFSA today?

Read more »

Canada day banner background design of flag
Investing

Got $500? 5 Top Canadian Stocks to Buy and Hold

These top Canadian stocks have solid fundamentals with potential to outperform the benchmark index by a wide margin.

Read more »

man touches brain to show a good idea
Energy Stocks

1 No-Brainer Energy Stock to Buy With $500 Right Now

Should you buy a cyclical energy stock at its decade-high? Probably not. But read this before you make a decision.

Read more »

Asset Management
Stocks for Beginners

TFSA: 4 Canadian Stocks to Buy and Hold Forever

Thinking about what to buy with the new TFSA contribution space in 2025? These four Canadian stocks are worth holding…

Read more »