Well you could. It seems like there is a lot of momentum and that the train is not running out of steam any time soon but you have to understand that there is a chance for permanent loss on investment. If you are willing to lose what you are going to put into it (i.e. not your life savings as a few people have done), feel free – but should the market crater sooner rather than later no one is going to have any sympathy for you. As for us, we are staying away because it is not in line with our investment philosophy.

They are speculative vehicles  – obviously anyone who disregarded our article on how weed stocks were overvalued two years ago made off like a bandit and we look stupid but we are firm in avoiding speculative stocks. If you get in early before the hype you are doing well and can laugh but for every one of these weed millionaires there are twenty weed peasants. And yes, laugh now, I am still far richer than you.

That said, we would separate weed from Bitcoin – weed does have commercial merit today.

Colt 45 and 2 Zig Zags

It will be sold and people do smoke pot – and presumably there are synergies with other consumer companies as evidenced by Constellation Brands’ investment in Canopy Growth and Diageo the alcohol giant snooping around for another deal to pair up with to 1) diversify their vice portfolios; and 2) have cross selling opportunities such as “weed-infused beverages”. It seems gimmicky to me and certainly not as much of a game changer as the fabled Four Loko.

What is more questionable is whether or not these current big names that are busy consolidating, have high patient numbers and are buying up warehouses will necessarily be enjoying the same market share their valuations may suggest.

On the other hand, Bitcoin’s commercial value still needs to be proven. There is absolutely a future for encryption and blockchain but picking the cryptocurrency and even the medium (possibly not cryptocurrency) is difficult.

Sizing the Commercial Cannabis Market

Weed valuations are pricing in recreational use versus just medicinal today. We can run a quick McKinsey sizing case here – although I will also caveat that I have never smoked weed because it is WRONG AND BAD, but let us say that 30 million (10% of Canada plus the US less certain conservative states) regular weed users toke up on the daily what is the market opportunity per year?

Excuse my abstinence but from my experience weed is a lot cheaper than alcohol so at $20 per week this represents ~$1,000 per person times 30 million equals $30 billion dollars. On the face of it, not bad. A lot of bong hits.

Now the thing is I do not see weed as a comparable to alcohol because while people will binge on alcohol consumption on a big night out I do not foresee people running to the weed bar and encouraging people to take the weed equivalent of shots.

Anyways, what I am alluding to is that it is not the nightlife lubricant that alcohol is and probably induces people to go to bed instead – not necessarily conducive to the business models of clubs and bars.

Now here is the final kicker. Tilray, and I admit I know not very much about them, is valued at $4.8 billion while Canopy Growth with its chic ticker WEED is valued at C$15 billion. Aurora is C$9 billion and Aphria is C$4 billion. So between these guys you already have almost $30 billion.

$30 billion eventually per year is just revenue. There are obviously costs and taxes that will be associated with this which means that the net income of these companies will be a lot lower.

So, now you can look at the margins associated with alcohol companies (the closest comparable) – I do not know off the top of my head but let’s say 10% – any higher and expect more entrants to start their own pot farms.

I would imagine that it is not a hard plant to grow although maintenance capital expenditures may be high. I base that on grow-ops destroying a few basements around me in the past from what I have heard from unfortunate landlords. Nonetheless I assume modern technology and major cannabis farms or labs will be much better.

This is simple microeconomic theory – high economic margins and low barriers to entry equals new entrants driving up supply and driving down cost. Expect the government to be heavy handed as a tax collector too.

Back of the Envelope Valuation for Recreational Marijuana

So $3 billion a year in net income for the industry – again let us look at recreational drugs that are legal (aka alcohol) for their trading multiple – we do this in investment banking all day. So Heineken N.V. and Diageo seem to be trading around 25x while Molson Coors is trading around 12x (another clever ticker – TAP) – 25x is a multiple that is either frothy or bakes in a lot of growth so let us say a mature weed industry trades around 12x.

This means $36 billion in equity value. Seems like we are already there with this legalization and rollout never to be found. With a 25x multiple, which would be beyond the bounds of region unless major population centers such as China and India decide that it is a good idea to have cannabis available for mass consumption overnight, this implies a $75 billion valuation. So depending on what your required return is, and let’s say 14% so a 5 year time horizon in accordance with the rule of 72 – do you see massive weed rollout and widespread consumption imminent globally?

Now again this is just back of the envelope math and they are telling me that Germany and Australia are frontier markets with huge revenue upside but seems like the valuation is stretched. But if I am wrong, that is fine – you can’t kiss every girl and you can’t win every trade.

I welcome comments on why I am wrong. Best answer gets to go to Dineen Coffee Co with me.

Long story short – Weed is becoming a socially acceptable business and the business has real commercial value (a lot of people smoke cannabis recreationally). No, I would not buy it.