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3 Pot Stocks I Wouldn't Buy With Free Money

Legal marijuana is one of the fastest growing industries on the planet right now, and there's a good chance things will stay that way for the foreseeable future. After licensed-store sales more than tripled from $3.4 billion to $10.9 billion between 2014 and 2018, Wall Street is calling for as much as $200 billion in worldwide annual sales by the end of the next decade. If these figures prove accurate, we could be talking about a compound annual growth rate of more than 27% through 2030.

There's no doubt that cannabis stocks have the potential to deliver game-changing returns to investors. But at the same time, investors also have to realize that not all marijuana stocks are necessarily going to be winners, or be able to hold onto their premium valuations. Even if Yours Truly were given a stack of free cash, there are three pot stocks I absolutely wouldn't buy.

A man in a suit putting his hands up as if to say no thanks.

Image source: Getty Images.

Canopy Growth

Despite being the largest marijuana stock in the world by market cap, and having one heck of a cash pile, Canopy Growth (NYSE: CGC) is a company I'd suggest investors distance their money from for a variety of reasons.

For numerous quarters, this biggest issue with Canopy Growth has been its aggressive spending. Flush with cash after an equity investment from Corona and Modelo beer maker Constellation Brands, Canopy Growth has been busy making acquisitions and pushing into new markets. Canopy Growth is spending $150 million to construct a hemp-processing facility in New York State, and it agreed to acquire Acreage Holdings in a cash-and-stock contingent-rights deal that was valued at $3.4 billion when it was announced in April.

Unfortunately, this spending is going to make it virtually impossible for the company to push toward profitability anytime soon. In fact, at this point, it's not even a guarantee that Canopy Growth sees a recurring profit until 2022, making it one of the last growers to push into the green, so to speak.

Canopy Growth is also without visionary co-CEO Bruce Linton, who was fired by his board in early July. Mark Zekulin, who's ascended to the role of CEO for the time being, will also be stepping down once a permanent CEO solution is found by the board.

To add the icing on the cake, Canopy's 15% gross margin in its most recent quarter was an industry low, and the 1.93 billion Canadian dollars in goodwill being carried on its balance sheet is liable to result in a future writedown. Despite being the largest pot stock, there's nothing redeeming about Canopy's current valuation.

A large marijuana dispensary sign in front of a cannabis store.

Image source: Getty Images.

MedMen Enterprises

Among the various markets where some sort of legal cannabis is being sold (either medically or recreationally), the U.S. stands supreme. Even with the federal government standing pat on its classification of marijuana as a Schedule I (i.e., illicit) drug, the bulk of all legal weed sales worldwide is derived from the United States. That should make multistate dispensary operators a particularly attractive commodity for investors. However, one vertically integrated company I want absolutely nothing to do with is MedMen Enterprises (OTC: MMNFF).

Now, don't get me wrong; I value the MedMen approach. This is a company that's generally catering to a more upscale consumer and is attempting to normalize the marijuana buying process. The problem is that while most of MedMen's peers have done a good job of minimizing their losses, MedMen's red ink has ballooned.

Through the first nine months of fiscal 2019, MedMen has lost $178.4 million from operations, inclusive of modest gains from biological asset revaluation. Even with significant cuts to the company's selling and administrative expenses, MedMen has hardly made a dent in its operating losses.

Making matters worse, the company is in the midst of acquiring privately held multistate operator PharmaCann. I say "worse," because this is an all-stock deal that could prove dilutive to existing shareholders. Further, incorporating PharmaCann's operational and planned stores into the fold means added outlays at a time when MedMen's spending and cash burn is already out of control, in my view.

It looks to be the worst of breed among multistate operators and may not have a shot at recurring profitability until 2021, at the earliest.

A small pile of one hundred dollar bills on fire.

Image source: Getty Images.

Cronos Group

Lastly, even free money wouldn't entice me to take a position in pot grower Cronos Group (NASDAQ: CRON).

Despite my distaste for Cronos Group, I do understand why investors have made it one of the largest marijuana stocks by market cap. Cronos netted a $1.8 billion equity investment from Altria that closed in March, giving it a pretty substantial war chest of its own to expand into overseas markets and make acquisitions. Given its added focus on high-margin derivatives, you'd think Cronos Group would make for a reasonable long-term hold. But there are numerous deficiencies here.

For one, Cronos Group trails its peers significantly with regard to production. Yes, I get that the company has more of a cannabinoid focus than sheer marijuana production. However, that doesn't excuse its inability to even land in the top-10 in terms of production or sales capability, which is a head-scratcher given its top-tier market cap.

I also worry about health concerns surrounding vaping impacting Cronos Group. Its alliance with Altria is built around the idea that vape sales will take off. But with 530 cases of mysterious lung illnesses recorded by the Centers for Disease Control and Prevention in the U.S. tied to vaping, this growing problem could result in a real loss of sales.

Also, like the other companies here, Cronos Group is far from a lock to be profitable on an operating basis anytime soon. Once a number of one-time benefits and derivative liability revaluations are removed from the equation, we see that Cronos Group isn't all that close to operational profitability. It's a pot stock that I feel is best avoided.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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