Aurora Cannabis (NYSE: ACB) Canopy Growth (NYSE: CGC) and Tilray (NASDAQ: TLRY) combined made less than $ $ 150 million last year, but all three marijuana shares have market caps of at least $ 6.7 billion, with Canopy's market value of $ 16 billion. We are talking about stratospheric price-to-sales ratios (P / S) for all three shares.
My Motley Fool colleague Sean Williams recently wrote that "no healthy investor can justify" Redeem valuation after the last quarterly update. Sean is going to think I've gone crazy, but I think it's possible that Tilray isn't too expensive.
Actually, I think Aurora, Canopy Growth and Tilray can even be big purchases. Absurd? Insane? Maybe, but just follow my mindset here.
A View of Valuation
I do not think any shares, regardless of the industry, should be valued on historical sales or earnings. Indeed, true valuation depends on future sales and earnings prospects.
So why do investors rely on historical valuation values so much? Because they help investors get a feel for what future results may look like. The problem for fast-growing companies is that historical performance does not benefit greatly from creating future sales and earnings.
To assess the valuation of high-growth stocks, investors are deliberately or unconsciously trying to do two things. First, they try to determine what the total addressable market for the business in question. Second, they make an effort to guess how well the company can perform and obtain part of the total addressable market.
Here it is important to note: The current and historical notion of a given stock often has little significance for any of these two factors. I think that's definitely the case with Aurora Cannabis, Canopy Growth, and Tilray. What we really need to focus on is the two key factors in the overall addressable market and the ability of the companies to succeed in that market.
A really large addressable market
Estimates of how large the global marijuana market can vary quite a lot. Let's start with the number that's probably thrown around most – $ 150 billion.
This figure comes from a UN report. It primarily covers estimated illegal sales of marijuana. We can reasonably assume that the majority of these sales are for recreational use of the drug. The problem with spending $ 150 billion is that only two countries have legalized the recreational pot so far.
However, 10 US states have legalized recreational marijuana activities. Several large states are likely to follow in their footsteps in the near future. Although Aurora, Canopy and Tilray cannot enter the US market while marijuana remains illegal at federal level, the chances of federal law changes appear to be better than ever.
We can't overlook medical marijuana, though. Larger countries all over the world have legalized medical cannabis, particularly Germany and the UK. Tilray CEO Brendan Kennedy said in the company's fourth conference that the number of countries that allow the legal use and sale of medical cannabis could "grow to 50 or 60 by the end of 2019".
It is also a great opportunity in the US now the hemp has been legalized. Cannabi's market research firm Brightfield Group is projecting that the market for hemp-based cannabidiol (CBD) could reach $ 22 billion by 2022. There is a lot of rosier forecast than others. Nevertheless, the potential for a multibillion dollar American hemp CBD market does not seem unrealistic.
Last year I spoke with Roy Bingham, CEO of Cannabis Market Research BDS Analytics, that he was addressing the potential global cannabis market size. He believed that the market could easily raise $ 100 billion in the long run, and this figure excludes Asian countries. Cowen analyst Vivien Azer projects that the US cannabis market itself could beat $ 80 billion by 2030.
For what it is worth, Constellation Brands (NYSE: STZ) used an estimate of that the global cannabis market could increase $ 200 billion over the next 15 years in its decision to invest in Canopy Growth. And Constellation ponied up $ 4 billion, so you think the big alcoholic beverage company did plenty of due diligence in its projections.
Arguments for Aurora, Canopy and Tilray
Based on all the estimates we have discussed, let us assume that the global cannabis market size by 2030 will be $ 100 billion. What market share will it take for the three largest Canadian marijuana producers to reach market coverage to justify their current valuation?
If we use a P / S ratio of five (roughly in the middle of average P / S ratio for the alcoholic beverages and the tobacco industry), Aurora Cannabis would need a market share of around 2%. Canopy Growth needs to catch just over 3% of the market. Tilray would need a market share of just under 1.5%.
Can these three companies achieve these levels? There are pretty good arguments that make Aurora, Canopy and Tilray easily exceed market share percentages.
All three companies already have solid international operations. Aurora, Canopy and Tilray are leaders in Germany, which has the largest legal marijuana market outside the US. My opinion is that all three companies can exploit their German business to win in other European markets. Canopy and Tilray are already moving into the US hemp market. Aurora probably won't be too far behind their rivals.
Canopy has his relationship with Constellation working in his favor. Aurora is working hard to coordinate business partners, and recently bottled billionaire investor Nelson Peltz as strategic advisor to facilitate deals. Tilray has teamed up with several major companies: Anheuser-Busch InBev Authentic Brands Group, and Novartis .
Sure, there are a handful of other companies that can be key competitors in the global cannabis market in the future. For example, Cronos Group stands out because of its partnership with the tobacco giant Altria .
Constellation Brands believes that Canopy could get up to 15% of the global cannabis market. If that projection is on target, it does not seem unreasonable to predict that Aurora could claim a 10% market share, with Tilray coming in at least 5%. Using these guesses, Aurora Cannabis, Canopy Growth and Tilray can potentially be worth at least triple their current valuations by the end of the next decade and perhaps much more.
I will be the first to admit that there have been many assumptions made. But it is a necessary evil when trying to determine the valuation of stocks in rapidly growing markets. It is quite possible that there are critical flaws in these assumptions that blow apart the theory that Aurora, Canopy and Tilray are not ridiculously expensive right now.
However, some of the assumptions may be far away and still allow these three peaks marijuana stocks to have a lot of space to run. Aurora Cannabis, Canopy Growth, and Tilray can only look like great once-in-a-lifetime bargains a few years from now. And some "crazy" investors today can laugh at the bank.