Buy quality and get good value.” Truer words have never been spoken when it comes to investing, and even in the emerging cannabis lab sector—whose unique value proposition we recently discussed here—such opportunities are being presented, many for the first time ever.

To find those opportunities, and to better highlight what fundamentals and operating characteristics to look for when selecting which cannabis lab stock(s) to buy, we’ve recently gained unprecedented access inside a fully licensed and operating cannabis lab.

What we gained there was both fascinating and quite valuable: A better working understanding of what happens behind closed doors, and three (3) defining qualities that may help separate an investment-worthy cannabis lab from a likely underperformer in the same sector. Let’s take a look…

Licensing & Certification

Just like investors wouldn’t want to own a company stock with no sales or earnings, it won’t pay to own shares of a cannabis lab that doesn’t have the necessary local and state permits, licenses, and certifications, either, as such a lab would not be operational and deriving revenue.

Licensing is actually a clear barrier to entry for the cannabis lab sector, and with only a handful of companies in each applicable state having been granted full licensing, cannabis lab investors essentially have a smaller and more manageable pool of company stocks from which to choose.

Currently, just eight (8) states have mandated cannabis lab testing, but with many more expected to follow suit in the short term, any cannabis lab that meets the current licensing requirements would be considered among the early benchmarks and well positioned to seek—and ultimately gain—licensing in states where cannabis testing and/or legalization is up and coming. In total, this would mean a piece of what’s expected to be an $850 million industry group by 2020!

Scientific Instrumentation & Processes

Undoubtedly, perceptions vary widely about both the degree and scope of the science and technology that are present inside a cannabis lab. The sheer newness of the industry means that many have never gone behind closed doors, but when we did, we witnessed firsthand the use of high-quality and high-tech instrumentation and testing equipment and processes designed to produce the most consistent and most accurate results.

Here are some of the critical functions happening inside a cannabis lab:

  • Potency Analysis: Cannabis contains more than 400 unique compounds, each with a different impact on the human body and health. Using a high-tech chromatograph, the cannabis lab scans, separates, and analyzes those compounds, producing accurate potency data that ensures proper treatment of various ailments without undue side effects or risk of overdose
  • Contamination Screening: Despite perceptions that cannabis is “natural” or “organic,” cannabis lab testing is a critical step designed and intended to detect and prevent serious health risks caused by unsafe levels of residual solvents, heavy metals, microbials, toxins and pesticides, and more, all of which could be found within the plant and its many unique compounds
  • Reporting and Data Storage/Aggregation: All cannabis lab report data is aggregated and stored in a centralized computer system and protected on behalf of the product owner, who is given printed reports and 24/7 access to searchable electronic data. This aids in functions such as compliance, product auditing and quality control, and more

In light of all the science involved, cannabis lab investors should give proper consideration to technology and the quality of a lab’s management team, as these are among the fundamental metrics that matter most in this space. Look for the latest instrumentation and technology, and for decorated leaders with a proven track record, who own scientific awards and patents, and who uphold the highest standards for accuracy and efficiency.

The “Ace in the Hole”: Is the Cannabis Lab Model Scalable?

While most target cannabis stocks for their explosive, shorter-term growth prospects, the cannabis lab industry boasts scalability and expansion possibilities that investors simply can’t find in other areas of the broader cannabis sector. In time, the most efficient and best-capitalized companies are expected to dominate the cannabis lab industry, hold licenses across multiple states, and establish larger-scale operations with the full benefit of a sustainable competitive advantage. Such stocks would offer immense value to investors that extends far beyond just a short-term investing horizon.

To identify the cannabis lab stocks best positioned to become tomorrow’s leaders, look for those with effective and well-documented processes and procedures, the means and competency to gain multi-state licensing, and the capitalization and cash flow to procure equipment and real estate interests. Also, look for a full range of proficiencies that include those post-testing functions like data storage, analytics, and consulting, as these are all high-margin services that add to a company’s unique value proposition.

What It Means for Investors

The underlying merits behind cannabis lab stocks are becoming better known all the time, but what’s not are the fundamental qualities investors should use to separate a high-quality stock in the space from a “growth trap” that’s lacking real promise and earnings potential.

To answer that, and to empower better and more informed investing decisions, we went inside a working cannabis lab and isolated three key items: Licensing, technology, and a “wild card” of sorts, scalability. So for current and prospective cannabis lab investors, mind the fundamentals and these three areas when selecting stocks, because in cannabis or any other sector, buying quality and paying a fair price for has always been the cornerstone of a successful investing strategy.

We’re making cannabis labs primary considerations in our own investment strategy, and will continue to inform and educate current and prospective investors. Please subscribe to receive updates and future investment ideas.

Michael Waldman Partner - Debtcraft