It's best to invest in valuable, promising companies when everyone else is ignoring their potential and bidding down their shares. However, blindly putting money into corporations just because they happen to have lagged behind the market is a terrible strategy. Many beaten-down stocks are performing poorly for good reasons. These types of stocks are known as falling knives in the investing trade, and here are two examples best avoided: Tilray Brands(NASDAQ: TLRY) and Innovative Industrial Properties(NYSE: IIPR). These two cannabis-focused companies are not worth investing in today. Read on to find out why.
1. Tilray Brands
Tilray has been a leader in the cannabis industry in the recent years. This market has been a major disappointment despite the hopes and expectations investors placed in it after encouraging regulatory changes in the company's home market of Canada in the late 2010s. Tilray has performed better than many of its peers but it has still has been an abysmal investment, declining more than 90% during the past five years. The company realized it needed to diversify its operations away from cannabis. Nowadays, Tilray is far from a pure-play pot company.
Its beverages segment looks somewhat promising. Tilray has become one of the largest craft brewers in the U.S. thanks to a series of acquisitions. Further, more regulatory progress could help boost the company's results. Last year, Germany legalized limited recreational use of pot for adults under very strict rules. In the U.S., cannabis could be rescheduled from a Schedule I substance -- the most restricted class -- to a Schedule III substance, which would represent some progress.
Substances in the Schedule III category are at least recognized as having some medical use. Further, Tilray's chief executive officer, Irwin Simon, is predicting that cannabis will become legal at the federal level during Donald Trump's presidency. If that happens, it might open up a world of opportunities to Tilray, not only in the recreational pot market but also in the market for cannabis-infused drinks. The company already has an established brand and beverage distribution network that could help it get a leg up on competitors. However, there is no guarantee things will move that way.
And even if they do, these opportunities will come with significantly more competition, including from companies experienced in developing and marketing highly regulated products. Furthermore, legalization might come with a set of rules that would hinder Tilray and its peers. That's what happened in Canada. Perhaps if the company had a track record of solid financial performance, it might have been worth considering the stock. But that's not the case.
Revenue growth has been inconsistent and largely attributable to acquisitions, while Tilray remains unprofitable.
Between the industry's problems and Tilray's failure to perform well, investors would be better off avoiding this stock even though it's just about as beaten down as they come.
2. Innovative Industrial Properties
Innovative Industrial Properties (IIP) is a real estate investment trust (REIT) that rents facilities to companies that grow cannabis. More specifically, IIP buys industrial properties from these companies and rents them back, so pot growers can avoid having money tied up in real estate assets. This is a critical service for U.S. cannabis companies, which often have trouble accessing funding due to the stringent regulatory landscape.
However, IIP has struggled with the rest of the industry in the past few years. Revenue and earnings growth has been unimpressive. The company pays a regular dividend, as every REIT is required to, but that, too, hasn't increased much during the past three years.
To make matters worse, IIP recently reported that its largest tenant defaulted on some of its rent obligations. This tenant, PharmaCann, accounted for 17% of IIP's revenue as of the end of the third quarter. IIP has encountered problems of this type before, but any time a big tenant defaults it's not a good sign. True, the company could solve the issues it is facing with PharmaCann. It could also expand its presence and reach throughout the U.S. Medical uses of cannabis are legal in 38 states and several territories.
IIP does business in only half of those, which grants the company significant growth opportunities even without federal legalization. That said, as long as the cannabis industry continues to struggle, it will be difficult for IIP to significantly improve its performance. The challenging regulatory landscape in the industry is what allowed IIP to get its foot in the door and become somewhat successful since it meant pot companies couldn't easily access funding and needed to find creative ways to raise cash. But this same landscape is partly responsible for pot companies performing terribly, which affect IIP's business.
Struggling, unprofitable companies are much less likely to meet their obligations. That's why investors should avoid IIP for now despite its dividend program and its huge forward yield of 10.2%.
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Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool recommends Innovative Industrial Properties and Tilray Brands. The Motley Fool has a disclosure policy.
