Following the industry bear market of 2019, many thought cannabis stocks would recover. Then came the coronavirus pandemic. Today, valuations remain 80% below their peak.
Marijuana companies are still hurting. Just look at Hexo (TSX:HEXO)(NYSE:HEXO). This $375 million business was once valued at $2 billion!
But this is far from the end. Marijuana consumption continues to rise, and companies are figuring out how to turn a hefty profit. For daring investors, this is the chance to make 10 times your original investment.
How to profit
While fortunes will be made during the next boom, not all cannabis stocks are created equal. Some will have significantly more upside.
Your best bet is to find companies that can overcome the effects of commoditization. This should be your number one priority.
Last year, before the marijuana bear market, I warned investors about the number one risk the industry faces.
“In the end, most cannabis production is not differentiated,” I explained. “That means it will sell at the same price per volume as any other cannabis.”
I stressed that the effects of commoditization will drive cannabis stocks for years to come.
“Importantly, commoditization also means that if prices get too attractive, new supply will be added to the market, pushing prices down over the long term,” I added. “Most importantly, it also means that suppliers will push hard to reduce costs; the only way to reliably make money in a commoditized market is to have a low-cost position.”
In order to profit with cannabis stocks, you need to find companies that can overcome this challenge. The best long-term strategy is through differentiation.
For example, Coca-Cola sells commoditized ingredients, but the company packages them in a way that achieves high pricing power. Consumers are willing to pay a big premium for water and sugar, as long as it says Coke on the bottle.
Marijuana companies must chart the same course. They need to figure out how to make customers loyal to value-add products that can withstand pricing erosion.
This cannabis stock will win
Despite a valuation of just $375 million, Hexo has a big lead in creating differentiated marijuana products. This was all part of its plan.
When cannabis stocks first took off in 2018, every producer rushed to bring supply online. Hexo was unique in that it focused on differentiation. That’s why it created the industry’s first cannabis platform. It provides the basic infrastructure that other brands can tap into.
For example, Hexo has a partnership with Molson Coors (TSX:TPX.B)(NYSE:TAP) to co-produce THC-infused beverages. Hexo provides the marijuana expertise, while Molson lends its globally-recognized brand.
Long term, cannabis stocks like Hexo will win. Marijuana consumption continues to grow, and certain brands will rise to the top. By partnering with existing brands that consumers already know and love, Hexo can leap ahead of the competition.
In some ways, Hexo mirrors the successful business model of tech stocks like Shopify, which simply build the basic infrastructure, allowing others to build on top. Shopify stock rose 30 times in value in just five years. Hexo could emulate that rise.