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Are you gullible enough to buy ASX pot stocks?

Ever since the start of stock markets several hundred years ago companies have been setup to exploit the general public’s voracious appetite for stocks considered to be in the next boom sector.

An example today is the proliferation of medical marijuana companies recently listed that claim to be ready to cash in on the ‘marijuana boom’.

Unsurprisingly, the ASX is a leader in this space with around a dozen “pot stocks” gaining increasingly large valuations as less-sophisticated retail investors buy into their stories on the back of stories framed by the changing legislative environment.

Legislative wheels roll slowly and legislation around loosening laws around the production, sale, and export of marijuana for medical purposes in Australia has been in the pipeline for a long time.

As such several companies have sprung up in an attempt to profit from the changes around cannabis use in Australia.

Auscann Group Holdings (ASX: AC8) has former politicians among its board members and has so far been the most successful medical marijuana hopeful in selling its story to the general public and media.

So successful in fact that it now has a market value around $407 million based on a share price of $1.47 with more than 276 million fully paid ordinary shares on issue as at its last disclosure to the market on May 15, 2018.

The company has 144.166 million ordinary shares quoted on the ASX and 132.707 million ordinary shares “not quoted” on the ASX. The share count is also likely to rise as options issued to insiders may be exercised to buy shares at prices substantially below today’s.

While this will benefit the owners of the options (if they’re in the money when exercisable) it will dilute ordinary shareholders in terms of any future earnings per share on issue.

But with a $400 million market cap Auscann must be turning big profits right?

Wrong, in fact it doesn’t even have any revenue as yet.

Yep, zero sales and a $400 million valuation, with nobody smoking reefers.

In its most recent quarter Auscann posted an operating loss of $1.5 million, with a forecast operating loss of $2 million in the current quarter. As at March 31 2018 it had $11.9 million cash in the bank to fund its high-growth plans and day-to-day operations.

So what does Auscann have going for it other than being in the popular medical marijuana sector?

Well it has Canada’s Canopy Corporation as a major shareholder and a tie-up with a Chile-based medical marijuana group now known as DayaCann.

Its management has also taken advantage of new legislation to secure various different permits or licences to import or export cannabis-based medical products, or grow marijuana to sell commercially for medical purposes in Australia.

It was the Jan 4 2018 news that the Federal government would permit the export of medical marijuana products that sent its shares from 84 cents to above $1.70 in early January in a move that shows how public sentiment around deregulation is driving the value of the company, rather than operational performance or cash flows.

Auscann will need to sell a huge amount of cannaboid-based medicines in the future to get anywhere close to justifying today’s valuation. With no revenue as yet it looks way over-valued and a good example of how the public’s appetite for “boom” stocks knows no credible limits.

Take note that serious investors buy companies with revenues and profits, while the penny stock end of the market is left to the less sophisticated punters and marijuana evangelists.

Others in the medical marijuana space with big valuations and missing revenues include MMJ Phyotech Ltd (ASX: MMJ) and Cann Group Holdings Ltd (ASX: CAN). I’d avoid them as well to look for companies spitting out consistent profits and dividends…

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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