1 stock I wouldn’t touch with a 10 foot pole

It’s probably best to avoid penny stocks, companies that trade for less than $5. If these were attractive businesses, investors, especially bargain hunters, would come in and buy their shares, bidding them up in the process. Although some penny stocks will end up facing this phenomenon and deliver long-term market performance, most will not. Some might think Tilray Brands (TLRY 3.21%)a company whose stock trades for just $2 at the time of writing has a chance to be one of those penny stocks on the road to huge returns.

It is one of the leaders in an industry whose regulatory landscape could improve in the coming years. However, the cannabis specialist is still not an attractive stock — quite the opposite.

The regulatory challenge

Canada legalized the recreational use of cannabis for adults in 2018, a move that has attracted a bit of a gold rush. Pot growers started popping up like weeds as investors rushed to buy shares of what looked like the most promising players in the field. Canada provides a good counterexample to the claim that friendlier cannabis laws will automatically lead to big profits in the industry. It’s hard to find a single cannabis stock that has had decent returns since 2018. Tilray is no exception.

Although it has a leading market share in Canada, organic revenue growth has been inconsistent and the company has grown its top line over the years, largely due to acquisitions. Meanwhile, profits have been elusive and gross margins have risen and fallen.

TLRY Revenue Data (Quarterly) by YCharts

Tilray’s results are partly because, despite the fact that Canada has legalized cannabis, it has set strict rules on who can get retail licenses. Meanwhile, many consumers continued to buy their products through illegal channels. The German market could face many of the same problems. Although the country has recently legalized some recreational uses of cannabis, there will be no retail stores. Instead, there will be social cannabis clubs that are allowed to grow the substance and share it among club members — but they will be run as nonprofit organizations.

No one under the age of 18 can join one of these cannabis clubs, no one can join more than one, and no one outside is allowed to obtain cannabis through it. Cannabis social clubs must also obtain government permission to operate. Alternatively, people can grow cannabis at home, but only up to three plants per person. These rules (and there are many more) do not sound conducive to helping Tilray substantially improve its financial results.

Tilray is diversifying, but it may not matter

Tilray’s business is now much more than just cannabis. The company’s push into beverages seems particularly interesting, at least on the surface. Thanks to a string of acquisitions, Tilray is now the fifth largest brewer in the US. For fiscal 2024, which ended May 31, the company’s adjusted gross margin for its beverage business was 46%. Tilray’s total adjusted gross margin was just 30%.

The company has just announced another move in this area. It will acquire four craft breweries from Molson Coors drink. Here’s the problem: these acquisitions are starting to have an impact on the company’s balance sheet. At the end of fiscal 2024, Tilray’s goodwill was about 47.6% of its total assets — that’s pretty big. Goodwill can represent the difference between the value of a company and the price paid by an acquirer for it. Too much goodwill can lead to write-downs and lower profits. So this could become a problem in the future.

Tilray still hopes that once pot becomes federally legal in the US, it will be in a better position than its competitors to dominate the cannabis-infused beverage market. There is no guarantee that the US will move in this direction, and even if it does, there is no guarantee that it will not look like the Canadian experience. Whether it’s cannabis or beverages, Tilray’s prospects look uncertain at best, and the company’s track record certainly doesn’t inspire confidence. This penny stock does not look like a long-term winner, so investors should stay away.