If you own a broad-based Canadian beta tracker, chances are you own upwards of five marijuana stocks.

Canopy Growth, the largest player in TSX-listed cannabis companies, is up 78-fold since July 2010. Aurora Cannabis, the other major player, has “only” been a 24-bagger since 2007. But if you really want to cherry pick, from that company’s bottom when it was a penny stock in 2013, it is up 49,180%. Sure, no speculation there.

You might be accidentally playing this mania without even knowing it. The S&P/TSX Capped Composite Index also has Aphria, CannTrust and Cronos Group sprinkled in. Granted, we’re only talking about 1.5% of total capital in the industry, but this group is so volatile that it punches well above its weight. What if the dot-com-ness of figure 1 gets flipped on its head?

J.P. Morgan analyzed 13,000 companies that were members of the Russell 3000 Index from 1980 to 2014 and found that 40% experienced a “catastrophic” loss. That means a decline of 70% or more in the price of a stock from its peak, after which there was little recovery such that the eventual loss from the peak was 60% or more.

What are your prime candidates for catastrophic loss? The Big Five banks? The rails? How about some companies that came out of nowhere, in a brand-new industry, owned by your not-around-during-dot-com next-door neighbour?

Think about catastrophic loss as you consider the outlook for the two biggies, Canopy and Aurora, in figure 2. I added the only other large Canadian health care firm (Bausch, the former Valeant), along with a few completely unrelated companies for some context.

Figure 2: Earnings per Share & P/E

The cannabis bulls will tell you that earnings in the coming years is not the proper valuation measure. But who among us knows what the marijuana world will look like down the road? I’m hard-pressed to see how Molson Coors, PepsiCo, Merck, British American Tobacco, or any of a dozen other giants will not try to get their hands on the pile of money that is supposedly sitting on the table. Continue Reading…