- Mistakes are common for even the best investors.
- The marijuana market is massive, but pot stocks have performed lousy.
- Doug Kass' post-mortem on his marijuana investing journey offers insight that stretches far beyond the cannabis industry.
One of the most difficult yet important tasks for any investor is objectively admitting when you’re wrong, changing course, and conducting a post-mortem analysis to reduce the risk of making the same mistake again.
That’s easier said than done. Admitting mistakes is tough. Financial pain hurts twice as much as gain, according to behavioral scientists. Take solace in knowing every investor, even those with decades of experience, will often be wrong. After all, investing in individual stocks is hard. The best investors are fortunate to produce positive returns on 50% to 60% of their stock picks.
Consider billionaire Jim Simons, the founder of the massively successful Renaissance Technologies’ Medallion hedge fund. His win rate was just 51%, yet his fund produced a compounded annual return of 39% after fees between 1988 and 2018. The decisions made in the fund were wrong 49% of the time, yet Simons produced awe-inspiring results that turned him into one of the world’s wealthiest and most lauded investors.
Frankly, the ability to set aside ego and honestly decant mistakes is an investing superpower few possess. Doug Kass is one of them.
In his Real Money Pro daily trading diary, Kass, a hedge fund manager whose career stretches back to the 1970s, admitted he was wrong to be as bullish as he’s been on marijuana stocks.
Make no bones about it, pot stocks have performed terribly, despite a market opportunity totaling tens of billions of dollars. Undeniably, the opportunity associated with shifting black market sales to specially-designed marijuana stores staffed by knowledgeable budtenders is alluring. However, revenue and profitability for publicly-traded cannabis companies have fallen short of optimistic outlooks, leaving investors disappointed.
Kass's honest assessment of what went wrong with his bullish view of marijuana stocks is important and contains many lessons for all of us. So, I’m including it in its entirety below. Hopefully, you’ll find, regardless of your own opinion about the future of legal marijuana, that many of his lessons learned along the way resonate, including for stocks outside the cannabis industry:
- "Learn from history and experience.
- Examining lessons from my foray into and exit out of cannabis stocks.
- Above all, do your own homework/analysis and never listen to paid "advisors" who, despite their protestations, lack objectivity and are rarely in your corner - keep your portfolios and children far away from them!
Warren Buffett once quipped that some company managements lie like Ministers of Finance on the eve of devaluation.
Last night's revelation that cannabis reform will not be attached to the Defense Bill - at a time in which many "advisors," analysts/industry experts, cannabis ETF managers, and company managements were confident of its inclusion - was a significant blow to the outlook for the cannabis industry's share prices.
It comes at a time, as I have noted, in which fundamentals are less than robust, the illicit market continues to make competitive inroads, demand/supply are still out of balance, and with accumulating industry debt loads and stretched capital ratios.
Over a two-day period (Friday-Monday), I unloaded much of my exposure to the space and followed up with at least five columns in my Diary explaining why. Most notably:
Selling Down My Cannabis Holdings
I have held my cannabis positions for a lengthy period of time.
As mentioned in the Comments Section, I have just now aggressively sold down my cannabis holdings across the board to relatively small-sized positions.
I will do a lengthy piece explaining my rationale for selling in the next day or two - but I am swamped right now!
To summarize, this decision has been based on my ongoing assessment of the industry's addressable market, management, finances, and legislative challenges.
Importantly, I have executed my sales based on my calculus of reward vs. risk relative to the cannabis industry's developing fundamentals - and in light of the recent runup in the sectors' share prices.
My sales today are an admission that my initial industry analysis was far too optimistic.
- Here is an important repost of a column written a few months ago:
Caveat Emptor: Don't Believe The Hype
- What I have learned from my unprofitable journey into investing in cannabis stocks... and how you can benefit from my mistake
Was the start of my last jam
So here it is again, another def jam
But since I gave you all a little something
That we knew you lacked
They still consider me a new jack
All the critics you can hang 'em
I'll hold the rope
But they hope to the pope
And pray it ain't dope"
- Public Enemy, Don't Believe The Hype
There have been few market sectors that have performed as badly as cannabis stocks.
While I got beat up, my losses were far from and nowhere near the general and large decline in the industry's shares over the last few years.
Here are some lessons that I have relearned about investing in cannabis stocks over the last two years, and for that matter, in most equities over my investment career:
- Be Independent In View: Pool all your resources and come up with a series of probable scenarios and weight each scenario by probability in order to develop a calculus and range of "values" in seeking a realistic upside reward vs. downside risk and in an attempt to ascertain a "margin of safety" in each investment you make.
- Be Realistic: In establishing the exercise (above) of evaluating an industry or company's prospects, avoid the hyperbole and exaggerated outcomes of others. Use common sense and logic of argument. At the very least, be objective - at most, cynical when evaluating their input.
- Fundamentals Trump Everything: While investors were starry-eyed about the longer-term promise of cannabis (and the large total market, TAM), the fundamentals were steadily deteriorating in 2021-22.
Analysts and investors steadily ignored these eroding fundamentals - I was late too but started expressing concern in late 2021/early 2022 in a series of negative columns - focusing too much on their perception of the potential treasures of the too-distant future.
- Evaluate The Orbit of Your Outside Resources: Avoid the confident of view in a world of uncertainty and with a wide range of outcomes, stay away from conflicted and biased paid "advisors" to companies, as they typically have an agenda that differs from yours. Keep these "types" away from your children and from your portfolios.
The value of the "insights" of paid consultants, in particular, is inverse to the number of their tweets or comments that they make on social media! To this day, they are still confidently tweeting out their bullish pablam with frequency! With the benefit of hindsight, there might have been more tweeps and tweets about cannabis than any other market sector extant. I and others should have recognized this earlier!
- Analysts Are Notoriously Bullish - Take Their Views With A Grain of Salt": I have run several sell-side research departments and one buy-side research effort - so I know of where they come.
There are exceptions, but in the main - and partially to maintain company relationships - brokerage firms (and the sell-side) exist to sell you merchandise. Their estimates are too often "group stink," gathered in a herd of closely gathered forecasts that essentially mirror company guidance.
Over time, analysts have universally presented the cannabis industry as a ticket to high returns with low risk - they were woefully inaccurate. Not surprisingly, they are still unrepentant about being so wrong-footed and still mostly bullish!
- Seek Out Competitors' Input: Try to speak to competitors to better and more objectively assess the lay of the land, as they can often tell you more than analysts, stock brokers and/or managements.
- Talk to Managements But Don't Take Their Bullish Views as Gospel: In the extreme, Warren Buffett once said that corporate managers sometimes lie like Ministers of Finance on the Eve of Devaluation. The Oracle's words have some substance.
- (Almost Always) Seek Out Superior Managements With Solid Accountants/Auditors and Financial Controls: Again, in retrospect, many cannabis equities failed to fulfill this characterization and recommendation. Remember when an accounting problem is revealed, more quickly, as there is never just one cockroach!
- Be Cynical With Regard to The Timing and Anticipation of Regulatory Change: Our representatives in Washington, DC, are not a group you can count on to produce timely and effective legislation - regardless of how compelling. With our political leaders' growing party bias, things have worsened. Change comes even more slowly, if at all, as cannabis investors have learned with regard to the steady promise of federal legislative initiatives (SAFE Banking, uplistings, etc.). As Gretchen was told in the movie Mean Girls, "stop trying to make fetch happen, its not going to happen."
- The Three Worse Words in Investing Are... "Total Addressable Market (TAM)": TAM is a crutch and often hard to refute because it is an abstract or conceptual factor many years out. My experience, and it is certainly the case for cannabis stocks, is that it is often subject to exaggeration and hyperbole.
I recall seeing charts of extraordinarily low 3-5 year EBITDA and sales multiples based on the projections of the analytical community. Some are still delivering them with regularity! Those estimates (based on TAM) were not worth the cost of the ink needed to produce them.
- When Looking for a "Bottom," Selling Call Premium Against Unloved Stocks Can Insulate Investors From Some Losses: This is exactly what I have done throughout the painful drop in cannabis stocks. I have consistently been short (high implied volatility) (MSOS) calls throughout my losing investment in the sector.
- A Low/Conservative Weighting (Particularly Of Out of Favor Sectors That Are Trending Lower in Price) Can Also Insulate Investors From Losses: I have never had more than 5% of my portfolio in cannabis stocks, sometimes far less.
One of the reasons my Diary is helpful to me is that when I make investment boners (which, in some periods, occur with frequency), I can go back and evaluate why - in the hope that I won't make the same mistake again.
My unprofitable sojourn into cannabis stocks are a good example of employing some discipline in a bad investment.
But today's opening missive has broader implications beyond weed.
Learn from my mistakes, I try to.”