All posts by Pat McKeough

A growth-by-acquisition strategy could stunt growth of marijuana producers

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Cannabis by the Numbers (TSINetwork.ca)

Expanding by acquisition can be risky in any business, but it carries even more risk in a new industry like marijuana production. Buyers could end up with companies whose revenues are completely dwarfed by their outsized market caps.

Many marijuana producers continue to grow quickly by acquisition.

Some are looking to diversify: either from medical marijuana into recreational cannabis, or into new areas like edibles. Most are/were simply looking to grab as much market share as possible before legalization on October 17, 2018. That’s because buying an existing grower is a much faster way to boost output than building a greenhouse from the ground up.

Canadian producers are also looking to expand internationally, including buying marijuana sellers overseas as medical marijuana becomes increasingly legal worldwide.

Higher chance of unpleasant surprises

In general, growth by acquisition is riskier than internal growth for a variety of reasons, but especially because acquisitions carry an above-average chance of unpleasant surprises. The buyer of something rarely knows as much about it as the seller. If a company makes enough acquisitions, it is bound to buy something with hidden problems. Eventually, those problems come out in the open and hurt the buyer’s earnings. Growth by acquisition in unrelated areas is especially risky.

That kind of expansion also tends to load up a company’s balance sheet with goodwill. Generally speaking, “goodwill” is the total price a company has paid for all acquisitions it has made over the years, minus the value of tangible assets that it acquired as part of its acquisitions. Goodwill is an intangible asset whose value can drop overnight if it turns out that the company made a bad acquisition.

The purchases that marijuana producers are making are particularly risky. That’s because they are mostly buying firms with huge market values: but with limited revenues and little chance of making a profit anytime soon.

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was first published on Aug. 22, 2018 and has been republished on the Hub with permission.

A calm perspective on the Cannabis Boom

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As you probably know, Canada plans to legalize recreational marijuana use in less than a month. You may not know that we recently launched a free email/web advisory, our TSI Cannabis Investing Bulletins. Our purpose is to give investors a conservative perspective on the cannabis industry and marijuana stocks.

Friends and business associates inside and outside the company wonder why we’re giving our cannabis newsletter away for free, especially with a cannabis stock boom underway. There are several reasons.

First, we only publish paid newsletters that focus mainly on high-quality investments. These are investments that are likely to provide you with long-term profits almost automatically, because they give you a way to tap into the long-term growth that you tend to get from buying common shares in well-established companies.

Share prices of all public companies, high quality or low, are sure to rise and fall unpredictably. But high-quality companies tend to accumulate profits, pay dividends, and benefit from the broad, lasting economic gains that accrue in Canada, the U.S. and other democratic countries.

Results will vary from one company to another, of course. Some of your favorite picks are bound to disappoint you. But gains from your winners will tend to overwhelm losses on your less-fortunate choices. As a result, when you invest in high-quality companies, time tends to work in your favour.

The longer you hold a diversified portfolio of high-quality companies, the more likely it is that you’ll show a profit, and the bigger that profit is likely to be.

Time works against you with low-quality investments

In low-quality investments, on the other hand, time works against you. These investments include stock options and other derivatives, and speculative stocks that have not yet established a pattern of success. For that matter, high-quality stocks can perform like low-quality investments if you engage in short-term trading.

We look on these areas as pastimes rather than investments. The profits are hit-and-miss. The losses you’ll suffer tend to overwhelm profits from the occasional big win: the reverse of the typical long-term pattern in high-quality stocks.

The big problem right now with investing in cannabis stocks is that these stocks are caught up in a boom mindset. Investors are focusing on the theoretical profits that might come from serving a vast new market created by cannabis legalization. They are disregarding the stock-market negatives. You might say they’re ignoring several of what we call the TSI Laws of Financial Physics.

Here’s one of the most powerful of these Laws: It’s easier to launch a stock promotion than to build a profitable company. That’s why bad stocks always out-number good ones. This is especially true in a setting like today’s cannabis boom.

When a speculative boom is underway, the profits from stock promotion mount up quickly. This attracts new promotors, and spurs the creation of more stock promotions. That inflates the bad-stock-to-good stock ratio even more.

Cannabis fans disregarding the business negatives

What’s worse, today’s cannabis-stock fans are also disregarding the business negatives. In past tech booms, for instance, successful tech businesses ultimately needed a technological advantage. In past mining and oil booms, success ultimately depended on finding mineral deposits that were worth exploiting, while the mineral they produced remained scarce and expensive.

Cannabis is an agricultural product: a plant. (Keep in mind that cannabis users refer to it as “weed” for good reason.) In the past, cannabis was scarce and expensive only because it was illegal. Legalization will cut production costs, and create a constant threat of surpluses. (Retail prices are likely to stay high due to taxes.) Continue Reading…

Tips for investing in gold — and how to hold gold in your RRSP

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At TSI Network, we’ve long recommended that you stay away from buying gold bullion, coins (unless you collect them as a hobby) or certificates representing an interest in bullion. If you are looking at investing in gold for 2018, there’s a better way.

That’s because gold investing in bullion does not generate income. Instead, bullion and coins come with a continuing cash drain for management, insurance, storage and so on.

Instead, we recommend that you limit your investing in gold to gold-mining stocks. Unlike bullion, gold-mining stocks at least have the potential to generate income.

However, if you do want to hold physical gold or silver in an RRSP, here’s how to do it:

More than a decade ago, the 2005 Canadian federal budget made investment-grade gold and silver coins, as well as gold or silver bullion bars, eligible to be held in an RRSP.

To be considered investment grade, gold coins must be at least 99.5% pure, and silver coins must be at least 99.9% pure. As well, only legal-tender coins produced by the Royal Canadian Mint are RRSP-eligible.

Bullion bars are also eligible for RRSP gold investing, as long as they are produced by a metal refinery that is accredited by the London Bullion Market Association. Accredited metal refineries include the Royal Canadian Mint and Johnson Matthey.

However, to hold the coins or bullion bars in your RRSP you need to find a third-party custodian of your coins or bars who will verify that you indeed hold the amount of bullion claimed, and report that to the Canada Revenue Agency on your behalf. Despite those safeguards, we do not recommend investing in gold through coins or bullion.

Investing in gold: a practical way to hold gold bars and coins in your RRSP

Questrade, a Canadian online discount broker, introduced its “Gold RSP” in January 2006. A decade later, in July 2016, this investment still meets all of the Canada Revenue Agency’s specifications, and makes it practical to hold coins or bullion bars in your RRSP.

To access the Questrade Gold RSP, you have to open a Questrade account. You can open an account with as little as $1,000. Kitco Metals buys the gold from the Royal Canadian Mint, and the gold is stored at the Mint, as the Canada Revenue Agency requires. Bid and ask prices are quoted on the Questrade web site, so you can buy and sell gold bars or coins if you want to bet on gold price fluctuations.

Questrade, on behalf of the Royal Canadian Mint, charges storage fees of about $0.10 per ounce of gold per month. There is no minimum number of ounces you need to hold, and no minimum storage charge.

Mistakes you should avoid when investing in gold

The first of the gold investing mistakes you should avoid is gold futures or options. Continue Reading…

The Future is not quite now: A calm perspective on gloomy predictions

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Here are a couple of conversations I’ve been involved in recently. Does any of it sound familiar?

Conversation with a retired engineer. He asked, “What do you think about this driver-less cars business? Has anybody even considered how many people this will throw out of work? We have to do something about this! Otherwise, joblessness will go so high that it will cause a depression.”

Conversation with a middle-aged family doctor/real-estate investor. He said, with complete confidence, “I’m cutting back on my medical career and moving into real-estate development. Long before I want to retire, I expect my job to disappear due to competition from AI (artificial intelligence).”

When listening to predictions, especially gloomy ones like these, keep in mind that nobody can consistently predict the future. Also remember that the most widely accepted gloomy predictions are especially prone to fail. That’s because people, as individuals, react to and prepare for predictions of doom. They work on the problem before its predicted arrival time. Sometimes they offset it entirely.

Y2K was the ultimate example

The ultimate example came on the first day of this century, with the non-arrival of the so-called “millennial bug,” or Y2K for short.

In the late 1990s, computer consultants warned that at the stroke of midnight on December 31, 1999, computers around the world would freeze up because of a problem with their data-storage limits. Computers used to use just two digits to designate a year. So they wouldn’t be able to tell what came after 1999; ‘00’ could mean 1900 or 2000. The problem had a simple fix, however. By the last day of 1999, most computer owners had attended to it. Damage from the predicted crisis was negligible.

Today’s predictions — gloomy and hopeful — revolve around the expectation that computer speeds will continue to rise, and computer costs to drop, at much the same rate as they have for the past half century.

This trend has led to exponential growth in the processing power of computer chips, coupled with an exponential drop in their cost. This leads to casual-conversation predictions like the two I mention above: artificial intelligence will soon lead to legions of unemployed taxi, truck and bus drivers; and legions of unemployed family doctors will follow soon after.

The logical flaw here is that exploding computer power at shrinking cost is a technological advance. But there are social, legal and practical limits to how quickly business can translate these technological gains into real-world progress (or problems, depending on how you look at it).

Computer makers don’t need government permission to raise the speed of their chips. In contrast, makers of driverless cars face all sorts of problems, long before they make any money.

The shift to driverless vehicles will happen gradually, over a period of decades. After all, driving in traffic involves far more surprises than a champion Go player faces on the playing board. Drivers have to deal with changing weather, full sunlight and deep shadow, unpredictable human drivers with varying skills, unpredictable pedestrian web surfers, potholes, snow-covered street markings and so on.

The shift from human to AI doctors will occur at an even slower pace — in line with how long it takes to earn a driver’s license on the one hand, and a medical license on the other. AI will replace family doctors some time after it replaces the voice and chat help lines that people use when they have a problem with a computer, a cell phone or a utility bill.

Assume technological process leads to economic progress

People have a long record of guessing wrong about the impact of new technology, and on how long it will take for the new technology to become part of daily life. You’ll guess right much more often if you just assume that technological progress eventually leads to economic progress. Continue Reading…

It isn’t what it used to be: Prospects for interest rates and inflation

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When I talk to serious, successful investors, few ask, “Do you think the central banks will raise rates two or three times by a quarter-point before the end of the year?” or “Do you think inflation will hit 3% in the next year?” They are more likely to ask things like, “What are the chances that interest rates and/or inflation will get back up to the peaks of the 1970s/1980s?”

That is a much more important question.  A quarter-point change in interest rates or inflation is a fluctuation. A return to the peaks of the 1970s/1980s would be a disaster.

No one can predict the future, of course. The easy way out on the question would be to say, “Oh no, that could never happen again.” But the productive way to address a question like this is to look at those earlier decades and to try to figure out what was special about them.

It seems to me that in the years prior to those decades, three specific political/economic factors worked together to unlock a lot of pent-up demand for money, goods and services, and funnel it into a narrow timeframe where it could have great impact. These factors helped spur the rise in interest rates and inflation that followed.

The first factor was that, during four decades between the early 1930s and the early 1970s, the U.S. managed to fix the price of gold at around $35 U.S. per oz.

Greenback became a world currency in three crucial periods

This helped set up the U.S. dollar as something of a world currency during three crucial, historic periods: the 1930s depression, World War II and the post-war boom. The role of world-currency issuer let the U.S. expand its money supply without burdening itself with a heavy load of domestic inflation — not burdening itself right away, that is. But eventually the $35 gold peg gave way, like a dam that bursts when the force of a rising river becomes too much. The breaching of that $35 barrier helped set off a worldwide wave of inflation, as the value of the U.S. dollar withered in relation to the value of gold. Continue Reading…