| Kit Winder | 26 June 2020 |
Another green transition
Why some stocks outperform?
After the 2008 financial crisis, some stocks recovered their losses within months. Then, during the subsequent bull market, these stocks outperformed the market. What was behind their growth? And how can investors spot similar stocks in today's market?
| | No, I did not have a religious experience while high on drugs, in case you misunderstood the subject line of this email.
This remains an investment newsletter.
But what if I told you that a company in one of the hottest and most loved sectors of the decade had grown sales by 150% into 2019, with great margins and a healthy net profit, but was only valued at 11x earnings? And that its first quarter results this year saw sales of more than double quarter on quarter (q-o-q) from 2019.
What's he on, you might wonder.
And what if I told you that it's part of a decades-long green transition?
Well you'd probably assume I was talking about a renewable energy or clean tech stock, right?
Well actually I'm not.
It's a pretty well-known cannabis stock.
I'd never actually heard of it – the whole cannabis investing thing passed me by to be honest. Once I'd heard about it, I was too late.
But now...
All the big cannabis stocks have fallen massively from grace. They've lost the public spotlight, and most of their previous gains with them.
Just look at Canopy Growth's five-year chart...
Source: Google Finance And so suddenly, I'm interested again. Because the companies are three years more established, with improved financials and established customer bases.
Big companies like Trulieve (described above), Green Thumb and Aurora, aside from the main ones which I believe are Canopy Growth, GW Pharma and Cronos, have all gone nowhere or backwards in recent years, in terms of share price.
Some are better than others from a financial perspective, and I can't be clear enough – I know nothing about the cannabis industry or which of these companies are better.
But these financials have piqued my interest.
And drugs are actually something of an interest of mine.
No, not like that. In fact, I may be unusual in that I've never even tried one (except alcohol of course). No cigarettes, weed, nothing.
But academically, I spent a year studying the history of the drug wars in Mexico, and my godfather is actually a brilliant documentary and film maker about the subject – mostly in South and Central America.
His three part series Cocaine looks at stories and people involved in the value chain of that particular drug in Peru, Colombia and Brazil, and my favourite, The Legend of Shorty, documents his (successful) search for the legendary El Chapo Guzman, leader (CEO?) of the largest drug cartel in the world, while he still evaded Mexican and American authorities, and even Sean Penn.
As with all such things, taking a closer look at these things doesn't make you understand it more, but less. Because you realise just how much more complicated these things are than you think. Books like Narcoland and Zero Zero Zero are great places to start, if you're interested.
But I went from being a young guy who opposed drugs without thought to one who was pro-legalising them but just against taking them myself.
But as with prohibition, the idea that somehow attacking the source of supply is the way to go is farcical.
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In fact, I wrote my dissertation on the history of Mexican government involvement in the drug trade in the 20th century. (There were three main phases – open complicity, hidden allegiance, and most recently a deliberate taking of sides in the hope of delivering victory and peace.)
The drug war is so costly in terms of money and lives and I find it pretty abhorrent, given what the money could be spent on instead.
Because in my view, drug addiction and usage should be seen primarily as an expression of desperation and escape from difficult lives. Look up the Rat Park experiments if you want to know why.
Essentially, a rat alone in a grey cage will choose the drugged water over the clean when offered a choice, soon becoming addicted and unhealthy as a result.
But that very same rat, when given a cage with toys and friends, will learn to deliberately avoid the drugged water, choosing the clean every time.
And when a heap of heroin-addicted soldiers returned to the US from Vietnam, they didn't bring their addiction with them, they left it behind along with the horrors and atrocities.
Do we blame cows for meat consumption, or cigarette or alcohol companies for those consumptions?
Not really, and we shouldn't. And governments shouldn't use the war on drugs as a political tool, because in Mexico alone over 100,000 innocents have been killed by cartels forced into existence by American politics.
Slowly, slowly, people are starting to realise that as with prohibition, you cannot quell demand by blocking supply. All you do is provide criminal organisations with lucrative revenue sources, and huge motivations for violence and aggressive control.
Also, it seems (though I know very little about it) that cannabis above all does have an array of medicinal purposes. I wonder how many lives could have been saved if we'd spent that money researching its benefits rather than making people kill each other for the right to sell it to us.
It's possible that the political war on drugs will go down as the worst policy ever, because of all the deaths it was responsible for both in terms of cartel violence, but also in lives which might have been saved if we'd spent the money on medical research, and community investment to alleviate the conditions which lead people to excessive drug use.
In my mind, legislation is the only, and inevitable solution to this.
We are still at the very beginning of understanding this at an international level.
Like it or not, drug use is no different to alcohol, which is itself responsible for stupendous amounts of death and devastation the world over. It burdens the NHS like nothing else – as do smokers.
And with both of these things, we've realised the best thing to do is tax the hell out of them.
Those two things alone (£25 billion in 2018) pay for an entire fifth of the annual NHS budget (£134 billion in 2019) in tax revenues. Give and take, I suppose...
The number of smokers, meanwhile, has fallen from 45% of the UK population to 15% last year, by various methods to discourage it, and better awareness of the risks.
When things are legal, you can do more to reduce demand – and this is where our efforts should be focused. Reducing demand, and helping those who suffer from addiction, as well as using the huge amounts of money we save from not fighting a multi-decade losing battle to address the socio-economic concerns in the worst-affected areas.
Just imagine if we made tobacco and alcohol illegal... You'd still want your nice bottles of wine, and perhaps a cigar or two to end the week. Lots of currently reputable wine merchants would find a way to get you your fix, for an additional fee of course. This is exactly what happened in prohibition in the US after WW1.
That is no different to most drug use. The only difference is that the government has given control of that business to criminal organisations. People still get what they want.
In the US, this also allows them to fill up the prisons, almost 10% of which are privately owned and so need to have lots of young, mostly African American drug users filling them up to balance the books.
I find this concept depressing and repulsive, to be honest, given my earlier argument that drug abuse is driven predominantly by socio-economic conditions, which in the US are significantly worse for African American and other minority communities.
In 2015, the Washington Post wrote:
| The two largest for-profit prison companies in the US – GEO and Corrections Corporation of America – have funneled more than $10 million to candidates since 1989 and have spent nearly $25 million on lobbying efforts... They now rake in a combined $3.3 billion in annual revenue and the private federal prison population more than doubled between 2000 and 2010, according to a report by the Justice Policy Institute.
| | What I'm saying is that although data showing that African Americans are arrested for drug-related crimes 6-7x more than white Americans, this is because they are disproportionately affected by the socio-economic conditions which lead to increased drug use.
Legalisation of drugs is a great wave, and with it shall come some relief to overburdened communities already struggling with problems enough.
Legalisation is not a cure-all, but it will save a huge amount of money and allow for increased medicinal applications and research.
This reasoning led to a huge boom in cannabis stocks a few years back and they ran up 10x or more in the space of a couple of years. Now, though they're way back down, the story rings just as true, and it's therefore a good time to get our binoculars back out, and hunt for some great value.
Remember, in the tech bust of 2000-2002 and beyond, the sector lost over 80% of its value from its peak.
But as with all these things, the bubble started from a grain of truth. No smoke without fire.
Like phoenixes from the flames, companies like Apple, Amazon and Microsoft are now the biggest companies and best investments of the millennium.
They are the reason people were so excited about tech and the internet back then – and they were right to be.
I see the legalisation train running along similar lines. It's a long-term trend that people were right to be excited about – they just got a bit ahead of themselves.
I know nothing about the stocks or companies involved, but I shall start devoting some of my time to learning about them from now on.
That's it from me for today. I'm working on another exciting stock top with James Allen for his renewable energy service subscribers. It's a brilliant little company with the technological prowess to really shake of the value chain in the battery space. It's not trying to be the winner, it's going to supply the winner.
Exciting times ahead.
Best wishes,
Kit Winder,
Editor, Southbank Investment Research
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