Cannabis stocks have been most exciting to watch over the past couple of years. They came out of the blocks screaming but then stumbled hard and fast. One thing hasn’t changed, which is the commitment of their fans to the bullish thesis. Cannabis investors have great conviction that these companies will prosper in the future. I have a healthy level of doubt but definitely not bearish. Cronos (NASDAQ:CRON) is one of the popular pot stocks to trade. While CRON stock has had great success of late, is also has major set-backs.
I’ll start with the conclusion first then back into the logic. Yes, this is a buy-able dip, but with the understanding that it may not be perfect. Therefore, investors would do well not to take full size positions for many reasons.
2021 could have another burst in stock prices when the legalization process actually starts. Else that’s an axe swinging above it. There is a lot of hope already in the price from the Biden presidency, so they better come through with action.
Investors who stuck with CRON stock in December captured a 130% rally. Going forward, it would be better if they settle down a bit. The pandemic gave birth to a new breed of traders who don’t believe in moderation. They are all in all the time, which is causing these massive swings. This will bring nasty consequences because nothing rallies forever. The longer a stock goes without a correction the harder it falls.
I am not predicting doom for CRON, but I am definitely waving the caution flag. My conscience is clear on that since I suggested going long during its tougher times. My goal is to find opportunities.
CRON Stock Fundamentals Have Improved
Cannabis stocks have tremendously improved their financial metrics. When they were at their hottest in 2018, the relationship between their sales and their market capitalization was ridiculous. Since then their businesses have matured enough so that the numbers have come down to a better balance. They are nowhere near normal yet, but neither is their opportunity.
The amazing thing about this group is that they are doing this while still illegal in the U.S. Some states have legalized marijuana, but it is still not legal on a national scale. This is testament to the courage and commitment that these companies and their investors have. You cannot short resolve like this for too long without good reason.
Therefore it comes down to picking proper entry points. By this I don’t mean seeking perfect spots, but rather avoiding obvious mistakes. I am not an expert on the intricacies of their business, but I know how to analyze financial metrics.
Cronos has consistently grown its revenues but their valuation is still out of whack. This is a growth industry so I don’t expect them to be profitable. The metric that I watch is the price-to-sales and 124 is extremely high. Buyers of the stock today are giving it credit for 124 years worth of sales now. That is a lot of hopium for them to live up to. This is far more expensive than competitors like Canopy Growth (NASDAQ:CGC), Aphria (NASDAQ:APHA) and Tilray (NASDAQ:TLRY).
Sooner or later, management will have to grow its sales to bring that back into balance. Zoom (NASDAQ:ZM) had that problem last year when it spiked. Cronos stock needs to shrink its P/S since it more than tripled. This doesn’t mean its prospects are not good or that I need to short the stock.
The Bulls Should Slow Down a Bit
Proof that it rallied too fast is that after losing 26% in a week it’s a still bullish channel. The uptrend is still intact even up after a massive drop. That is a ferocious appetite for risk that the bears should avoid.
It has a support zone below but not one hard line. I expect buyers to be waiting between $11.50 and $10 per share. This has been an area of contention since December 2017, so I expect it to play a role again. On the way down these pivot spots are support.
Those who want to own shares for the long term can nibble but not go all-in. Regardless of how good the thesis is for this stock, it has to trade inside the whole market. Therein lies a problem because the indices are even wilder than cannabis stocks. We could have an overall correction and drag CRON stock with it.
Get Long With Room to Spare
This is where I like to use the options markets to create a buffer for my risk. Instead of buying shares I would sell the CRON October $9 put. For this I collect $2.20 per contract, which is a net credit into my account. The worst that could happen is that I own Cronos shares at a $9 cost. My breakeven would then be $6.80 because I collected money to sell the put. I sleep easier knowing that I have a 40% buffer before I start losing money from ownership.
This does not allow me to participate in the upside more than what I collect. But it is a 20% rally equivalent and that’s great. I can live with those compromises knowing that I don’t have to sweat every red tick. Also that I don’t even need a rally to win because time is doing the work for me. I never sell naked puts unless I really want to own the shares.
When it comes down to it, the success of a company’s stock is tied to its success on main street. The mentality of investing in “stonks” is dangerous because it assumes that there’s only one direction for price. I’ve been trading for decades and know that this is false. Fads come and go and new traders will sooner or later learn consequences to their actions. Life has a way of giving us the test before the lesson. Wall Street street evolves but there are laws of physics we can’t defy. In fact, legislators debated it just yesterday.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.