Most marijuana stocks claim astronomically high valuations. That's because investors anticipating tremendous growth have clamored to buy the stocks. But this expected growth also helps those same investors feel as if they're not overpaying for these stocks.
As I was researching some stocks recently, I stumbled across a surprising valuation metric for one of the biggest marijuana stocks in terms of market cap -- GW Pharmaceuticals (NASDAQ: GWPH). Based on this valuation metric, the cannabinoid-focused biotech stock actually looks dirt cheap. But there's more to the story.
Image source: Getty Images.
Don't hang your hat on this PEG
The price-to-earnings-to-growth (PEG) ratio for GW Pharmaceuticals is 0.35, according to data from Thomson Reuters. A PEG ratio below 1.0 is usually viewed as a sign that a stock could be undervalued. GW Pharmaceuticals' PEG ratio is really low, so is the stock really undervalued?
At first glance, it might seem to make sense that the biotech stock could be a bargain. After all, GW Pharmaceuticals recently won FDA approval for the first plant-based marijuana drug, Epidiolex. Market research firm EvaluatePharma thinks that Epidiolex will become one of the top new drugs launched in 2018, with sales of around $1 billion by 2022. It doesn't seem too far-fetched that rapid earnings growth fueled by GW's new drug could make the stock look cheap based on the PEG ratio.
That's what I thought might be the story when I first noticed GW Pharmaceuticals' super-low PEG ratio. But I was wrong.
First of all, GW Pharmaceuticals is losing money right now. The biotech is also expected to be unprofitable next year. This means that the company's price-to-earnings (P/E) multiples are negative. For GW to truly have earnings growth, it must first have positive earnings.
Second, Wall Street analysts surveyed by Thomson Reuters aren't projecting that GW Pharmaceuticals will increase its earnings. The average five-year estimate of annual earnings "growth" is -50.3%. That's right -- analysts think GW's bottom line will deteriorate rather than improve.
So how did GW Pharmaceuticals warrant such a seemingly attractive PEG ratio? The negatives on the P/E ratio and the earnings growth projection cancel each other out. Basically, GW's low PEG ratio is as fake as a three-dollar bill.
Different evaluations of GW's valuation
I think the negative five-year growth projection from Thomson Reuters is inaccurate. The growth estimate for GW Pharmaceuticals next year is 40.4%. My hunch is that the five-year figure simply hasn't been updated lately. In my view, GW Pharmaceuticals should be on track to significantly improve its bottom line with the launch of Epidiolex later this year.