Alpha Available, Get Your Alpha!
Cannabis is full of Alpha For Now...
President Biden made the historic announcement that his administration is moving to reschedule cannabis from Schedule 1 to Schedule 3. This announcement is a step in the right direction for cannabis and for our society. I believe cannabis is the Great Replacement for what people are already consuming, but it is just a lot less toxic than the alternatives.
If you remember, it felt like I was one of the few people that believed that Biden was serious and that his administration would move faster on rescheduling than expected back in 2022. Here is what I wrote:
I think the Biden administration has started the process to end the prohibition on cannabis and that the administration will either reschedule cannabis to schedule 3 or lower, or de-schedule cannabis altogether and that it will happen by the end of 2023.
My timing was off by five months, still not bad.
To me once cannabis is officially rescheduled (my best guess is by end of September), the real game of investing in cannabis will begin. And the ultimate goal beyond just profits is generating alpha, or outperformance. And right now there continues to be lots of alpha available. It’s important to focus on why.
First, due to the Federal illegality of cannabis, there are few institutional investors and few analysts conducting fundamental research.
Second, the few cannabis investors and analysts that do exist tend to focus on the top five largest companies and generally ignore the other companies.
Third, within the small cannabis investing community most investors focus most of their attention on Federal and State government news, technical trading trends and what the top executives say or tweet.
To a fundamental value investor like me this is music to my ears. I have found little or almost no discussion of unit level economics, Return on Invested Capital (ROIC), sensitivity analysis to different pricing environments, Cost of Goods Sold (COGS) and actual repeatable free cash flow generation.
All of this has led and should continue to lead to alpha because what generates value in the long term is free cash flow growth, companies with COGS advantages and reinvestment runways.
I continue to believe that there is tremendous alpha in cannabis, but with today’s news it probably marks the beginning of that starting to change. More investors are likely to get involved and the alpha will slowly but surely disappear over time.
Just remember what Charlie Munger said:
“I have a friend who says the first rule of fishing is to fish where the fish are. The second rule of fishing is to never forget the first rule.”
Right now there are lots of fish and few fishermen. I plan to enjoy it while it lasts.