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Stocks  | June 9, 2019

Although the past five weeks have been a rough go for marijuana stocks, the legal cannabis industry has been virtually unstoppable for years. We've witnessed Canada become the first industrialized country to legalize recreational marijuana, seen the U.S. Food and Drug Administration approve its very first cannabis-derived drug, and sat back as 33 U.S. states have now given the green light to medical marijuana in some capacity.

Although it will require patience on the part of investors as the nascent legal pot industry matures, marijuana stocks offer the potential of being a once-in-a-generation growth story. The question is, which marijuana stocks should you buy?

While diversifying within the cannabis industry isn't exactly easy, there are five marijuana stocks that I believe would make up the perfect marijuana portfolio -- or, as I prefer to call it, a "pot-folio."

CannTrust Holdings

To begin with, you can't have a pot-folio without owning at least one cannabis grower. Though there are more than a dozen mid-tier and major growers to choose from, none offers better long-term value at the moment than CannTrust Holdings (NYSE:CTST).

CannTrust has been beaten to its roots of late following a wider-than-expected fourth-quarter loss and a recent shelf offering that involved selling north of 36 million shares at $5.50 apiece, which was almost 15% lower than where the company was trading prior to the capital raise.

But here's the deal: CannTrust's cash raise will fund its acquisition of up to 200 acres of land that will be used for 100,000 to 200,000 kilos of outdoor-grown weed. Though some of this cannabis will undoubtedly wind up in dispensary stores, most of it will be processed for derivative production, such as edibles, cannabis-infused beverages, concentrates, and so on. Derivatives are a considerably higher-margin product than traditional dried cannabis, so this is CannTrust's way of diversifying its product line and ensuring that its margins are among the best in the industry.

The company also intends to grow a combined 100,000 kilos a year via hydroponic grow methods at its flagship Niagara campus and much smaller Vaughan facility. With cheap access to water and electricity, these grow sources should yield per-gram production costs that are lower than the industry average. All told, that's 200,000 to 300,000 kilos of eventual annual output for the low, low market cap of $737 million.

Trulieve Cannabis

In addition to Canadian exposure through CannTrust, you'd want a diversified pot-folio to have exposure to the United States' burgeoning marijuana industry (even if it is illegal at the federal level). That's where Trulieve Cannabis (NASDAQOTH:TCNNF) comes into play.

Trulieve is a Florida-based vertically integrated cannabis company that controls its product from seed to sale. Since the transport of marijuana isn't legally allowed outside of state lines by the federal government, it means dispensary operators like Trulieve are usually wise to own their cultivation sites, processing centers, and retail points, so as to save on costs.

What makes Trulieve so special is that, while it does have a presence in California, Connecticut, and Massachusetts, in addition to Florida, it's really stayed grounded in its home state. Of its 30 open dispensaries, 28 of them are in the Sunshine State, which has allowed Trulieve a commanding market share lead in medical-marijuana-legal Florida.

As the dominant Florida dispensary, Trulieve's branding has done the talking, and it's resulted in relatively low operating expenses. In 2019, Trulieve's sales should more than double to a range of $220 million to $240 million, with $95 million to $105 million in adjusted EBITDA. By 2020, the company foresees sales hitting up to $400 million. Put simply, there's no profitable pot stock anywhere with a lower forward price-to-earnings ratio than Trulieve Cannabis.

Charlotte's Web Holdings

No pot-folio is going to be complete unless you have direct exposure to the cannabidiol (CBD) craze. The easiest way to do that it to buy into North America-focused Charlotte's Web Holdings(NASDAQOTH:CWBHF).

According to aggressive estimates from the Brightfield Group, sales of CBD, the nonpsychoactive cannabinoid best known for its perceived medical benefits, could soar from $591 million in 2018 to $22 billion by 2022, working out to a healthy 147% compound annual growth rate. Since CBD can be found in a bounty of derivative consumption options, and derivatives are the preferred choice of consumption for younger cannabis- or hemp-product users, this high-margin extract can make for a very profitable venture for CBD-focused companies.

Right now, there's not a company out there that has a greater hemp-derived CBD product market share than Charlotte's Web. This is a company that, as of the fourth quarter, had its oils, topicals, and capsules in 3,680 retail doors. However, following the passage of the farm bill in December, which made industrial production and hemp-derived products legal in the U.S., Charlotte's Web has increased its retail door count past 6,000.

As with Trulieve Cannabis, Charlotte's Web is notably profitable, and is likely to stay this way given the low-cost nature of growing hemp and extracting CBD. With the company more than doubling its hemp grow space to 700 acres from 300 acres, significant growth looks to be in the cards.

KushCo Holdings

Beyond marijuana stocks that touch the plant, I'd suggest that the perfect pot-folio also needs at least one solid ancillary player. This is where KushCo Holdings (NASDAQOTH:KSHB) steps in.

If you were to look at KushCo's performance in recent months, you'd note it's not pretty, and I wouldn't disagree. An accounting snafu led to an earnings restatement for 2017 and 2018. Further, margin weakness in its vape product operations has weighed on results. Thankfully, neither of these issues is all that serious. The accounting corrections had no impact on revenue, cash on hand, or cash flow, and margins will be greatly helped by passing along vape-related tariff costs from Chinese imports onto consumers. This latter remedy should be of little concern, given the enormous appetite for vape products in the United States.

Meanwhile, KushCo looks to capitalize on three fronts. First, it's a packaging and branding solutions specialist that helps more than 5,000 pot companies comply with federal, state, and/or local laws. Second, there's the aforementioned vape product business. And third, KushCo provides hydrocarbon gases and solvents used in the respective production of cannabis oils and concentrates. Since derivatives are growing in popularity, KushCo aims to be an indispensable middleman here, too.

Though profitability is still likely a year or two off for KushCo as it invests in the infrastructure needed to be successful in this budding industry, you won't find a marijuana stock with a lower future price-to-sales ratio.

Flowr Corp.

The last thing you need for the perfect pot-folio is something niche, and a bit of a wild card. This perfectly describes small-cap Canadian pot grower Flowr Corp. (NASDAQOTH:FLWPF).

Now, I know what you're probably thinking and, yes, you're right -- it's another pot grower, and we already have CannTrust. But unlike CannTrust, and pretty much every other marijuana grower (with the exception of Supreme Cannabis Company), Flowr is focused specifically on developing ultrapremium cannabis strains. The premium and ultrapremium markets have far less competition than average and discount cannabis, with Flowr pretty much the only grower to see rising per-gram prices for dried cannabis in its most recent quarter.

The interesting thing about focusing on high-end cannabis flower is that it caters to a completely different clientele. Most affluent pot users are all about the experience, and they share little or no allegiance to more traditional cannabis culture. That makes these affluent marijuana users less likely to shift their buying habits if the economy undergoes a hiccup, and more willing to accept price increases by a company like Flowr.

Flowr's efficiency is also projected as tops in the industry, with 300 grams of yield per square foot. Working hand-in-hand with researchers at Scotts Miracle-Gro's subsidiary Hawthorne Gardening, Flowr aims for up to 450 grams in yield per square foot at some point in the future. Despite only producing 50,000 kilos a year from its Kelowna campus in British Columbia, this premium grower should deliver some of the top margins among cannabis growers.

These five marijuana stocks make up what I believe to be the perfect pot-folio.

A revolutionary initiative is helping average Americans find quick and lasting stock market success.

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