Pity the average cannabis stock investor. Since 2021, shares of the largest cannabis fund, the AdvisorShares Pure US Cannabis ETF (NYSEARCA:MSOS) have lost over 80% of their value. Many companies have fared even worse. MedMen (OTCMKTS:MMNFF) — once considered the “Apple store of weed” — has seen its valuation plummet from $1.7 billion to $40 million, a 98% drop. Aurora Cannabis (NASDAQ:ACB) has fallen 99.5% from its peak value.

Underlying these woes has been a persistent shortage of demand… at least the legal type. Revenues at the top 100 cannabis companies worldwide hit only $16 billion in 2022, barely half the estimated $30 billion Americans spend annually on the drug. (By comparison, we spend roughly $22 billion annually on chocolate, and $18 billion on cheese). Persistent oversupply has also cratered prices. By Q1 2022, Aurora Cannabis lost 1.55 CAD for every 1 CAD of cannabis sold into the consumer market. It was a classic supply-demand problem. Without U.S. legalization, the industry found itself with too much weed and too few customers.

But that is quietly changing. Since mid-2023, several top cannabis companies have seen a pickup in pricing and demand, particularly outside the tough business-to-consumer market. One cannabis firm even saw a 137% increase in its sports nutrition beverages. (More on that later).

Wall Street analysts, too, have been revising their forecasts upward. One of the firms mentioned below has seen earnings per share (EPS) estimates pushed up double-digits, and the other could become profitable as early as next year.

Deep-value investors will sense an opportunity. These two firms trade for fractions of their peak valuations. And as they innovate beyond consumer cannabis, they’re setting themselves up to become more diversified and far less dependent on the bad business of selling marijuana to retail customers.

A Word of Warning

Investors need to be hyper-selective with cannabis companies. The average cannabis stock scores a D by my MarketMasterAI system, which is historically associated with losses over the next six months.

The consumer marijuana market also remains badly oversupplied. Aurora’s consumer segment still loses 1.01 CAD for every 1 CAD it generates in the market. Consumer prices have also continued to fall double-digits this year as more efficient strains come on the market. The business has become so hyper-competitive that even a former marijuana SPAC decided to take a ticketing firm public instead.

That’s why these two companies are such outliers. By investing early in alternative businesses, these firms have created revenue streams beyond the sale of cannabis.

2 A-Rated Cannabis Stocks to Buy: Canopy Growth (CGC)

Canopy Growth (NASDAQ:CGC) was founded in 2013 to help convert an old Hershey’s chocolate factory into a marijuana grow-op. It was a quick success. By 2017, the company was generating over $25 million annually in gross profit, and Modelo parent Constellation Brands (NYSE:STZ) would add an enormous $4 billion stake the following year. Shares would eventually peak in the $50 range, briefly making Canopy Growth the most valuable marijuana company in the world by market capitalization.

Rising losses, however, soon proved too great to ignore. By 2022, the company was losing upwards of $1 billion annually. Even Constellation Brands would make significant moves to shield itself from this now-toxic asset. In June, Canopy Growth raised doubts about its business as a going concern.

But cost cuts are finally beginning to kick in. Analysts now expect the Ontario-based firm to generate $43 million in gross income in fiscal 2024, its first positive figure since 2021. Earnings estimates are also getting revised upwards — a typically bullish sign. Since June, the average earnings per share estimate has jumped from -48 cents to -30 cents. The average revision has been up 24.8%. It’s no surprise that MarketMasterAI has now upgraded Canopy Growth to an A grade for its positive momentum.

That means Canopy’s rock-bottom prices now create an intriguing gamble for deep-value investors. The company’s shares are cheap, at least on paper. Canopy trades at less than 70% of book value — a third of its long-run average. And the firm is hyper-focused on reining in costs. In September, the firm sought bankruptcy protection for one of its subsidiaries to help offload debt.

Of course, Canopy’s stock remains exceptionally volatile. The company only has $431.5 million in cash left — barely enough for 12 months of operations at current cash burn rates. Marijuana  also remains a challenging business, making up half of the firm’s revenues. But Canopy’s management is making all the right moves for their firm to survive. If luck goes their way, shares could rise as much as 200%.

Sundial (SNDL)

Alberta-based Sundial (NASDAQ:SNDL) saw the same collapse in the consumer-based marijuana industry. Operating losses ballooned from $10 million in fiscal 2018 to $281.1 million in 2022 as expected U.S. legalization continued to get pushed back.

Fortunately, Sundial’s management foresaw the decline. In 2022, the company merged with Alcanna, the largest private-sector alcohol retailer in Canada by number of stores. Roughly 84% of the $320 million deal was financed by issuing new shares, while the remaining $54 million was paid by cash.

The financing was a masterstroke. By using its relatively overvalued shares to buy up Alcanna, Sundial managed to walk away with a profitable business while paying dimes on the dollar. The same deal today would theoretically cost Sundial shareholders only $130 million. Meanwhile, Alcanna’s liquor business has kept cash coming in. In Q2, liquor contributed 8.2 million CAD in operating income — 3.5X more than Sundial made on cannabis retail.

The company has also seen improvements in its underlying cannabis business. In August, the company announced net revenue from its cannabis retail segment had seen a 13.2% year-over-year increase, a record since Sundial diversified into the segment. This was driven by a 3.3% increase in same-store growth, and an increase in store locations. Cannabis operations — the wholesale and production end of Sundial’s business — also saw an 81% surge in revenues from acquisitions.

Aggressive cost-cutting measures have now turned Wall Street positive on the stock. Analysts expect Sundial’s management to cut operating losses to near-zero this year. The firm could become profitable as early as 2024 at current rates.

That’s pushed Sundial into A grade territory, according to the MarketMasterAI stock-picking system. A cheap stock price, improving fundamentals, and positive stock momentum are all historic signs of a turnaround waiting to break out. Though Sundial has seen a terrible set of years, its dose of self-help is beginning to pay off.

What About Tilray? Curaleaf? Green Thumb?

There’s an unfortunate truth about the global marijuana industry: It remains oversupplied, hypercompetitive, and overall a bad business. At least 388 companies surveyed by Thomson Reuters deal with cannabis, and these firms lost a combined $11.3 billion last year.

Companies like Tilray (NASDAQ:TLRY), Curaleaf (OTCMKTS:CURLF) and Green Thumb Industries (OTCMKTS:GTBIF) are particularly at risk. Most of their business is caught in this unprofitable industry, and management didn’t have the foresight (or resources) to diversify earlier. They essentially bet on the marijuana industry and lost the wager.

The good news is that these firms will benefit if the U.S. federally legalizes marijuana. High operating leverage cuts both ways, and even getting a breakeven quarter could send shares of these stocks up triple digits. These companies have a relatively high short interest percentage.

But history tells us it’s still the wrong moment to bet on a turnaround. Since June, Wall Street analysts have cut earnings targets for Tilray by an average of 39%, earning it a D grade overall. Curaleaf and Green Thumb have seen 3% cuts each, giving them B grades. Though marijuana reform laws are making their way through Congress, history tells us that it’s better to focus on the early winners now than to jump in too early on the second-wave winners.

As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.