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Friday’s mini-crash and why the marijuana stock bubble is about to burst

And there it is, ladies and gentleman - the Tilray, Inc. (NASDAQ:TLRY) crash, on which so many traders were betting. This week’s most talked about marijuana stock ended the rollercoaster down $53.35 per share to  $123.00, a -30.25 percent loss. The tumble was arguably predictable given the recent volume of short sales and put option trading in combination with the overwhelming evidence of the stock being overvalued.

After all, Tilray’s Wednesday high of $300.00 was 85 times estimates for its 2020 year sales and 340 times that year’s estimated cash flows.

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Even when the stock was last analyzed on September 6 when the price per share was only $80, analysts felt it should market perform (i.e., not grow any faster than the S&P 500) and its consensus price target was $34.50. Another source reported Wednesday that they priced it at $40 and named it the “poster child of the cannabis bubble.”

Since earlier this month, Tilray has since increased over 50 percent as of Friday’s close compared to the S&P 500 return of 1.8 percent, and the price has diverged even farther away from analyst valuations. Given these figures, it might seem unimaginable that the stock reached the $300 high Friday.

While much of the price inflation was due to Tilray stock share scarcity and a market of investors urgently wanting to enter the cannabis industry, the lack of business fundamentals to support the price made it susceptible to such a collapse. Some would argue the stock was due for a correction.

Cannabis stocks overall observed losses Friday

Although Tilray was an extreme example of overinflated cannabis stock values, there’s also evidence that the overall marijuana industry is also overvalued; a bubble ready to burst. ETFMG Alternative Harvest ETF (NYSEArca:MJ), the only U.S.-based ETF and credible representation of the North American marijuana market, also took a hit Friday. In the past year, the ETF has yielded a 21.8 percent return. However, its current valuation puts its current price at 10 times the valuation since December 2017, so it might not surprise some that an industry correction was due.

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The ETF fell 8.63 percent Friday, partially due to its 3.2 percent holdings in Tilray. However, the more substantial influence on the loss was from its largest holdings which include Canopy Growth Corporation (NYSE:CGC), which is 10.72 percent of MJ holdings, Cronos Group (NASDAQ:CRON), 8.94 percent of MJ holdings, and Aurora Cannabis Inc. (TSX:ACB), 8.32 percent of MJ holdings. These stocks fell 5.00 percent, 9.02 percent, and 2.83 percent Friday, respectively.

Here’s a closer look at analyst valuations compared to current market prices for four other leading marijuana stocks to help determine if Tilray was an outlier within the industry or an industry prototype for future marijuana stock price corrections.

Source: Market Screener

Other marijuana industry leader stock valuations

Unlike Tilray which is trading between three to eight times what analysts are currently showing, these four other industry leaders do not have as much indication of price inflation. Based on Thomson Reuters data summarized on MarketScreener.com, they are trading at prices within analyst valuation ranges. In fact, Aurora and Aphria are both unanimously considered strong buys in recent analyst reports, while Canopy and Cronos are still expected to outperform the overall market.

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Aurora, Canopy, and Cronos’ current prices are overvalued compared to the Medium Valuation, and all four are overvalued compared to the Low Valuation, so further price corrections are still possible. However, Friday’s losses with these four big players along with others within the industry could have been a reaction to the Tilray decline more so than an indication of a bubble bursting.

The marijuana industry is an environment where investor sentiment has a substantial impact on price patterns. The intrinsic stock value might be difficult to evaluate until the industry matures.

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