The capital structure of a company and of an industry has major influence. Companies that are new to the world of public trading have a lot to learn, including the understanding of who owns shared and the price those shares are owned at, which hold more weight than just the forecast of where the business could go. News media website Grizzle recently posted an article to bread down the capital structure of stocks in the cannabis industry, which is still fairly new in many states.
Dilution, which occurs when a company increases the number of shares by issuing new shares, making the share worth less individually. However, there are a few factors that are necessary to consider for this market. For instance:
Grizzle included several graphics to show where the top cannabis stocks are positioned, including how significant dilution is and their current stock price (as of August 27th). Specifically, their data included Aleafia Health, C21 Investments, Curaleaf, Dixie, Emerald, Green Growth Brands, Hexo, iAnthus, Kushco Holdings, Liberty Health Sciences, and others. See where each one stands in the graphics below, keeping in mind that the larger circles indicate more dilution.
While the Grizzle article shows other companies as well, the point is clear – cheap stock weighs heavily on stock prices. Cheap shares create two situations –
Early investors can be both good and bad for a stock, depending on the activity that happens after. These investors get companies off the ground, creating startup capital for the brand that eventually leads to the public markets. Companies that are lucky enough to find investors with the same priorities can make the shares more stable and will ultimately create a source of additional revenue as time progresses. However, early investors that just want to turn a profit quickly and leave could end up selling early, dropping the price, and leading to more losses.
Independently, cheap shares aren’t really an issue, and any company that already has financial issues has had to drop their shares well below the market price. Companies that have been in business for years are familiar with the changing share levels. However, as they state, having a cost basis that is close to the current stock prices will provide less of an incentive to sell, because potential gain is smaller.
In this chart, there are three main conclusions that can be drawn:
The future stock price still appears to be heavily influenced by the early efforts that the company makes in fundraising, which the cannabis industry has learned. Everything from the creation of products to distribution to the growth of sales had to be ready almost immediately, but the speed of getting the funds for these efforts had to be just as fast. The depth of an option in the money is a determining factor in how likely it will be converted for cashing out, which can be seen in the chart below.
Cheap shares can be a problem when stock volume is too low to accommodate the diluted shares sales. In this case, the supply will be more than the demand, which means that the stock price will drop, but cheap shares don’t mean that the stock will be stuck where it is.
Companies need to make their shares valuable with the growth of revenue and earnings, which will allow the early investors to sell their shares and gain a profit. Companies that already have a foundation will bring in more interest from institutions to help increase trading volumes, which means that insider stock sales won’t likely have much of an impact on the price.
Grizzle makes several recommendations to anyone that is looking to invest, saying that the companies that they choose should:
The recent industry selloff in the cannabis industry appears to be driven by multiple factors. While cheap shares and insider selling clearly contributes to the selloff, it is hardly the only factor. However, while prices are low, this may be a good month to choose stocks that have promise to grow.
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