MJBizMag March 2021 - 15

stock at high prices to fund those highreturn
projects.
In an ideal world, GameStop would
have sold as much new stock as it
could after a tenfold increase in its
market capitalization-which, ironically,
would let them better fight their secular
headwinds. But market dynamics
probably prevent this.
Though not currently in a squeeze,
cannabis stocks traded up double
digits (an average of 19% for U.S.
operators and 55% on average for
Canadian operators) after the Jan. 5
" blue wave " of Democrats' Senate wins
in Georgia and Aphria's better-thanexpected
earnings report.
With that investor enthusiasm,
18 companies announced or issued
$1.6 billion in new capital. While some
of this capital will be allocated into
high-return new projects, some will be
invested in disappointing projects-or
even wasted on poor decisions and
bad business models.
The key to determining that is the
incremental return on invested capital
(ROIC). If the ROIC is high, the capital
is used to expand high-return projects
to the benefit of shareholders and the
industry. Smart investors are happy
about this.
Real-World Applications
Some projects could generate lower
returns than expected, such as when
excessive capital raises led to excessive
cultivation capacity in Canada.
Ultimately, total supply was 2½ times
demand, which led to declines in cannabis
prices that pressured margins
and eventually reduced the returns on
capital until new managers began to
reduce excess capacity.
Or the capital might simply be spent
on low-return luxuries for self-interested
management at shareholders' expense.
Determining the kind of investments
companies are making requires
understanding the fundamentals of
the business, the strategy, the uses of
the new capital and the incentives and
past behavior of management.
Over time, the only true value will
be created by businesses providing
desired services to paying repeat
customers at good margins-not hoping
to sell a never-profitable, low-ROIC
business to a greater fool.
Mike Regan is the founder
of MJResearchCo.com and a
regular contributor to Marijuana
Business Daily. He and fellow
analyst Colin Ferrian can be reached
at mikeandcolin@mjresearchco.com.
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MJBizMag March 2021

Table of Contents for the Digital Edition of MJBizMag March 2021

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