Why Tilray, Aurora Cannabis and Canopy Growth glow green

What happened

A funny thing happened in the cannabis market today. Analysts at investment banking Wells fargo launched industry-wide coverage, warning of overvaluation among marijuana companies and suggesting investors look to suppliers of hydroponics instead – but marijuana stocks have jumped nonetheless.

At 12:35 p.m. ET, shares of Tilray (NASDAQ: TLRY) gain 4.6%, and both Aurora Cannabis (NASDAQ: ACB) and Canopy growth (NASDAQ: CGC) are up 7.1% each.

Image source: Getty Images.

So what

The Wells Fargo Wrath This Morning is the last company on this list – Canopy Growth. As the analyst warns, Canopy Growth is unlikely to make enough sales to break even anytime soon without federal action for legalize marijuana sales in the United States. Investors seem to misinterpret this prediction today and take the Warning like a promise this when as legalization occurs, Canopy (and its peers) will suddenly become profitable.

And yet, even assuming legalization is imminent, it is not clear how quickly Canopy Growth can become profitable, leading the analyst to conclude that “the weakness [in Canopy Growth’s stock price] is [not] a buying opportunity “.

Now granted, a negative review for Canopy Growth doesn’t necessarily mean bad things for Aurora Cannabis and Tilray as well. But at the last report, Canopy “won” a negative operating profit margin 107% on its sales. Tilray is not profitable either (negative 19% operating margin) and Aurora’s margins are actually worse (negative 119%) than the other two.

Now what

Suffice it to say, these aren’t big numbers, and while an increase in marijuana sales through legalization in Washington, DC may help, well, Aurora sales are. already in size 13 times in the past five years, according to data from S&P Global Market Intelligence. Canopy Growth’s sales increased 15 times, and Tilray’s sales increased by approximately 37 times. If this level of sales growth has not been enough to bring this industry up to profitability, it’s hard to say how much more growth would be needed to make the deal.

Perhaps this is why Wells Fargo’s advice to marijuana investors is to avoid large cannabis companies altogether and instead invest in vendors such as Scotts Miracle Gro (NYSE: SMG) – whose share is also up 7.9% today – on the theory according to which the “leader of the lawn / garden and hydroponics … can benefit from the upheavals of the market. .. to consolidate more shares “and develop its activity.

And I have to say: this argument makes a lot of sense. If sales growth at large marijuana companies is contributing to the oversupply of marijuana, driving down prices, and preventing companies like Canopy Growth, Aurora Cannabis and Tilray from making a profit, it makes sense that a company like Scotts , who sells the products needed to increase those marijuana sales in the first place, must have a bright future ahead of them.

It’s a lesson as old as California: don’t buy gold miners. Instead, invest in people sell them pickaxes and shovels.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns stock and recommends Scotts Miracle-Gro. 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.