Doug Kass throws in the towel on pot stocks; The dangers of cannabis, especially for youth
One of the reasons why my friend Doug Kass – who manages hedge fund Seabreeze Partners – is one of my favorite investors and investment writers is that he marries experience, wisdom, and confidence with humility.
Pretty much everyone who manages money has the confidence part down pat – a lot of Type-A "Masters of the Universe" – but very few have even a smidge of humility, which is equally important.
Look at the all-time greatest investor, Warren Buffett...
Sure, he has an ego – "my idea of a group decision is looking in a mirror" – but he's also very humble, regularly saying most investments are outside of his circle of competence and berating himself for mistakes he has made.
I think Doug shows similar humility and wisdom in his recent missive, in which he explains why he has sold the pot stocks he owned and what his mistakes were.
I, too, have been completely wrong on this sector and am considering following Doug out the door.
That said, I worry that today's sellers might be bottom-ticking the sector – especially given that it's year end, when anyone who owns these dreadful stocks wants to sell to take a tax loss, plus professional investors want to get them off their books so they no longer have to explain their mistake.
So I'm going to wait until at least mid-January before deciding whether to withdraw my recommendation of the AdvisorShares Pure U.S. Cannabis Fund (MSOS)...
Here's Doug...
More Lessons Learned
December 7, 2022
* Learn from history and experience
* Examining lessons from my foray into and exit out of cannabis stocks
* Above all, do your own homework/analysis and never listen to paid "advisors" who, despite their protestations, lack objectivity and are rarely in your corner – keep your portfolios and children far away from them!
Warren Buffett once quipped that some company managements lie like Ministers of Finance on the eve of devaluation.
Last night's revelation that cannabis reform will not be attached to the Defense Bill – at a time in which many "advisors," analysts/industry experts, cannabis ETF managers and company managements were confident of its inclusion – was a significant blow to the outlook for the cannabis industry's share prices.
It comes at a time, as I have noted, in which fundamentals are less than robust, the illicit market continues to make competitive inroads, demand/supply are still out of balance and with accumulating industry debt loads and stretched capital ratios.
Over a two-day period (Friday-Monday) I unloaded much of my exposure to the space and followed up with at least five columns in my Diary explaining why. Most notably:
Selling Down My Cannabis Holdings
December 5, 2022
- I have held my cannabis positions for a lengthy period of time.
- As mentioned in the Comments Section, I have just now aggressively sold down my cannabis holdings across the board to relatively small-sized positions.
- I will do a lengthy piece explaining my rationale for selling in the next day or two – but I am swamped right now!
- To summarize, this decision has been based on my ongoing assessment of the industry's addressable market, management, finances and legislative challenges.
- Importantly, I have executed my sales based on my calculus of reward vs. risk relative to the cannabis industry's developing fundamentals – and in light of the recent runup in the sector's shares prices.
- My sales today are an admission that my initial industry analysis was far too optimistic.
Here is an important repost of a column written a few months ago:
Caveat Emptor: Don't Believe the Hype
September 19, 2022
* What I have learned from my unprofitable journey into investing in cannabis stocks... and how you can benefit from my mistake
There have been few market sectors that have performed as badly as cannabis stocks.
While I got beat up, my losses were far from and nowhere near the general and large decline in the industry's shares over the last few years.
Here are some lessons that I have relearned about investing in cannabis stocks over the last two years, and for that matter, in most equities over my investment career:
* Be Independent in View: Pool all your resources and come up with a series of probable scenarios and weight each scenario by probability in order to develop a calculus and range of "values" in seeking a realistic upside reward vs. downside risk and in an attempt to ascertain a "margin of safety" in each investment you make.
* Be Realistic: In establishing the exercise (above) of evaluating an industry or company's prospects, avoid the hyperbole and exaggerated outcomes of others. Use common sense and logic of argument. At the very least, be objective – at most, cynical when evaluating their input.
* Fundamentals Trump Everything: While investors were starry eyed about the longer-term promise of cannabis (and the large total market, TAM), the fundamentals were steadily deteriorating in 2021-22.
Analysts and investors steadily ignored these eroding fundamentals – I was late too but started expressing concern in late 2021/early 2022 in a series of negative columns – focusing too much on their perception of the potential treasures of the too distant future.
* Evaluate the Orbit of Your Outside Resources: Avoid the confidence of view in a world of uncertainty and with a wide range of outcomes, stay away from conflicted and biased paid "advisors" to companies, as they typically have an agenda that differs from yours. Keep these "types" away from your children and from your portfolios.
The value of the "insights" of paid consultants, in particular, is inverse to the number of their tweets or comments that they make on social media! To this day they are still confidently tweeting out their bullish pablum with frequency! With the benefit of hindsight there might have been more tweeps and tweets about cannabis than any other market sector extant. I and others should have recognized this earlier!
* Analysts Are Notoriously Bullish – Take Their Views With a Grain of Salt: I have run several sell-side research departments and one buy-side research effort – so I know of where they come.
There are exceptions, but the main – and partially to maintain company relationships – brokerage firms (and the sell-side) exist to sell you merchandise. Their estimates are too often "group stink," gathered in a herd of closely gathered forecasts that essentially mirror company guidance.
Over time, analysts have universally presented the cannabis industry as a ticket to high returns with low risk – they were woefully inaccurate. Not surprisingly they are still unrepentant about being so wrong-footed and still mostly bullish!
* Seek Out Competitors' Input: Try to speak to competitors to better and more objectively assess the lay of the land as they can often tell you more than analysts, stockbrokers and/or managements.
* Talk to Managements But Don't Take Their Bullish Views as Gospel: In the extreme, Warren Buffett once said that corporate managers sometimes lie like Ministers of Finance on the Eve of Devaluation. The Oracle's words have some substance.
* (Almost Always) Seek Out Superior Managements With Solid Accountants/Auditors and Financial Controls: Again, in retrospect, many cannabis equities failed to fulfill this characterization and recommendation. Remember when an accounting problem is revealed more quickly, as there is never just one cockroach!
* Be Cynical With Regard to the Timing and Anticipation of Regulatory Change: Our representatives in Washington, D.C. are not a group you can count on to produce timely and effective legislation – regardless of how compelling . With our political leaders' growing party bias things have worsened. Change comes even more slowly, if at all, as cannabis investors have learned with regard to the steady promise of federal legislative initiatives (SAFE Banking, uplistings, etc.). As Gretchen was told in the movie Mean Girls, "stop trying to make fetch happen, it's not going to happen."
* The Three Worst Words in Investing Are... "Total Addressable Market (TAM)": TAM is a crutch and often hard to refute because it is an abstract or conceptual factor, many years out. My experience, and it is certainly the case for cannabis stocks, is that it is often subject to exaggeration and hyperbole.
I recall seeing charts of extraordinary low 3-5 year EBITDA and sales multiples based on the projections of the analytical community. Some are still delivering them with regularity! Those estimates (based on TAM) were not worth the cost of the ink needed to produce them.
* When Looking for a Bottom, Selling Call Premium Against Unloved Stocks Can Insulate Investors From Some Losses: This is exactly what I have done throughout the painful drop in cannabis stocks. I have consistently been short (high implied volatility) (MSOS) calls throughout my losing investment in the sector.
* A Low/Conservative Weighting (Particularly of Out of Favor Sectors That Are Trending Lower in Price) Can Also Insulate Investors From Losses: I have never had more than 5% of my portfolio in cannabis stocks, sometimes far less.
Bottom Line
One of the reasons my Diary is helpful to me is that when I make investment boners (which, in some periods, occur with frequency), I can go back and evaluate why – in the hope that I won't make the same mistake again.
My unprofitable sojourn into cannabis stocks is a good example of employing some discipline in a bad investment.
But today's opening missive has broader implications beyond weed.
Learn from my mistakes, I try to.
Thank you, Doug!
I'll add that contributing to the terrible sentiment around the sector are these recent articles:
- Marijuana majority (New York Times). Excerpt:
Some leading lawmakers have not followed the shift in public opinion. Biden has said he opposes jailing marijuana users and pardoned thousands of people convicted of marijuana possession under federal law. But he also opposes legalization, putting him at odds with more than 80% of self-identified Democrats.
Lawmakers' opposition has led activists to rely largely on voter support to enact legalization. Of the 21 states where recreational marijuana is or will soon be legal, 14 approved the change through ballot measures.
But there are limits to the ballot process. Not every state allows such initiatives. And the drug remains illegal at the federal level, stopping most big banks from working with marijuana businesses and raising the businesses' tax bills.
Even in states where voters approve legalization, marijuana may remain illegal. South Dakotans voted to legalize marijuana in 2020, but Gov. Kristi Noem, a Republican, took the measure to court and won. This month, South Dakotan voters rejected another legalization initiative.
- The Progressive Paradox on Marijuana (Wall Street Journal). Excerpt:
A study published last week in the journal Radiology finds that smokers who used marijuana (often in addition to tobacco), instead of tobacco alone, had higher rates of emphysema, airway inflammation, and other conditions. "There is a public perception that marijuana is safe and people think that it's safer than cigarettes," one radiologist told the Journal. "This study raises concerns that might not be true."
Where might people have gotten the idea that marijuana is safe? To blame politicians for this would vastly overstate their persuasive powers. Yet it's remarkable how liberal politicians have tried to take a rhetorical puff to fit in with the cultural cool kids. On April 20, which is cannabis culture slang, Twitter was a veritable haze.
I also worry about the dangers of cannabis use. A friend e-mailed me recently:
I have a teenage son and just found out some of his friends are trying out edibles. While he says he doesn't do it, I feel like I need to make sure. Can you please resend the article you sent around last month about people dying from laced marijuana?
I replied:
It wasn't pot but cocaine laced with fentanyl: Three New Yorkers Ordered Cocaine From the Same Delivery Service. All Died From Fentanyl.
I am not aware of anyone dying from pot laced with fentanyl (nor did a quick Google search reveal anything), but you are right to be concerned about his potential use of cannabis. Smoking a little weed has historically not been particularly dangerous, but cannabis today is 50 times more concentrated than what our parents smoked at Woodstock, which is resulting in frightening outcomes – see these three New York Times articles:
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.