Charlotte's Web (OTC: CWBHF) is having a rough 2020. Not only is it continuing to struggle to grow its sales amid the pandemic, but the Drug Enforcement Agency (DEA) also released interim rules on hemp processing in August, making the stock a riskier investment. Down around 60% this year, shares of Charlotte's Web are underperforming the S&P 500 and its 6% returns thus far. Even the Horizons Marijuana Life Sciences ETF isn't doing nearly as badly, falling 27% year to date.
But recently, investors have become more bullish on the hemp stock, and it's up around 20% in just the past month (both the Horizons ETF and S&P 500 were up around 5% during that time). Is this a sign that the stock has recovered, or is it a brief pause before shares of Charlotte's Web plummet further? Let's take a closer at whether now may be a good time to invest in the company.
Why there's been so much pessimism around Charlotte's Web
Charlotte's Web has been struggling to generate sales growth, but that's not exactly a new development. In its most recent quarterly results, released on Sept. 14 for the period ended June 30, sales of $21.6 million were only slightly higher than the $21.5 million the company reported in revenue for the previous period. However, when compared to the prior-year period, sales were down 13.6%. The company has been stuck in a range between $21.5 million and $25.1 million in sales for seven straight quarters.
That's in stark contrast to how well the cannabis industry has been performing amid the pandemic. Illinois broke state records for recreational pot sales in recent months, and western states like Oregon and Colorado have also seen revenues surge since the outbreak of COVID-19.
Other problems for hemp companies like Charlotte's Web include the DEA and the interim rules it released pertaining to hemp in August. The DEA essentially said that a substance needs to stay at or below the 0.3% tetrahydrocannabinol (THC) level, even during the extraction process. Otherwise, it's considered a Schedule I substance and therefore, illegal. During the extraction process, the THC level can temporarily rise above 0.3%, which is worrying hemp companies and their investors. The DEA's rule isn't final, and it's not clear what possible consequences there may be for companies in violation of it. It's an added risk, nonetheless, which has likely kept Charlotte's Web's stock down in recent months.
Is the stock finally cheap enough to make it worth buying?
Charlotte's Web's recent rally suggests that investors are willing to buy the stock despite its challenges. The stock hit an all-time low of $2.14 in early October; even now, it's still trading around where it was in March when the markets crashed. With losses in four straight quarters, a good way to evaluate the stock today is using the price-to-sales (P/S) ratio. Here's how Charlotte's Web compares on that metric against some other cannabis companies:
Relative to some of its peers, Charlotte's Web is a bit expensive, but not by much. The important takeaway from this chart is that cannabis investors are simply not willing to pay steep premiums for many of the industry's top stocks anymore. A year ago, Charlotte's Web was trading at a P/S ratio of more than 15, and today, it's nowhere near that multiple. And given the risks that hemp stocks are facing right now amid the DEA's interim rules, compounded with growth challenges for Charlotte's Web, you're left with an investment that may not be all that safe or even attractive for growth investors.
Why the worst may still be ahead for Charlotte's Web
There are a couple of reasons why I wouldn't be surprised to see Charlotte's Web's stock fall further down.
The first is that its recent sales numbers are coming at a time when the industry as a whole is still doing well. The pandemic has led to some strong numbers for the cannabis industry, and if those trends begin to die down, Charlotte's Web's sales numbers could decline, potentially below the $20 million mark. The second reason is that if the DEA's interim rules become final and are enforced, hemp stocks could see a wave of risk-averse action from investors.
A decline in sales would already bring the stock down if its current P/S ratio were to remain intact. But if investors also see more risk associated with the stock, they could also adjust the P/S multiple they're willing to pay for Charlotte's Web, which could send the stock down even if sales remain constant. There's a potential for a one-two punch from the aforementioned factors that sends shares of Charlotte's Web down to a new bottom.
Should you buy Charlotte's Web stock today?
Charlotte's Web is a company that I'd avoid investing in for the time being. The cannabis industry can be very volatile, and the DEA's rules, along with the company's struggling sales numbers, make the stock too much of a risk right now. Its valuation also isn't terribly cheap when compared to its overall revenue. Cannabis investors are better off looking at other stocks to invest in -- ones that could get a boost on next month's election results.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Charlottes Web Holdings. The Motley Fool recommends Charlotte's Web. 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.