Cannabis stocks really took a beating in 2019 and in the first part of 2020. In fact, on March 23, Tilray (NASDAQ:TLRY) shares were down 94.5% since the beginning of 2019. Since that time, however, cannabis stocks have come roaring back to life and in early May, TLRY stock also got a boost from better-than-expected first-quarter earnings numbers.

The market has rallied on optimism that government stimulus and a novel coronavirus vaccine will help save the economy. In addition, cannabis stocks have been boosted by headlines suggesting cannabis could potentially help treat or protect from the coronavirus.

TLRY stock is now up nearly 150% from its March lows. Things may be looking up for cannabis stocks these days. However, Tilray may have an even more explosive catalyst ahead than its peers.

TLRY Stock Fundamentals

When a stock like Tilray drops nearly 95% in less than a year and a half, at least one of the following two things has happened. First, something fundamental has completely broken with the company. Or second, the stock never had any business being at its peak price to begin with.

I would argue that Tilray’s massive sell-off in 2019 and early 2020 was a result of the latter explanation. Tilray’s all-time high market cap was above $20 billion back in 2018. That’s a downright absurd valuation for a company that just reported $52.1 million in revenue in the first quarter.

But valuation aside, Tilray’s fundamentals in the quarter were fairly impressive. The company exceeded consensus analyst expectations on sales, earnings, and cash burn. It reiterated its full-year margin and cash flow guidance. Tilray still expects to reach break-even earnings before interest, taxes depreciation and amortization by the end of the year.

“All in this was a good qtr compared with the company’s erratic 2019 quarterly trends,” Cantor Fitzgerald analyst Pablo Zuanic said. “That said, lack of [long-term] guidance re EBITDA and cash flow (other than break-even EBITDA by 4Q20) and perhaps optimistic [operating cash flow] expectations for 2020, all make EBITDA-based valuations difficult.”

Cantor Fitzgerald has a “neutral” rating and $8 price target for TLRY stock.

The Catalyst

Tilray’s fundamental numbers may be enough to propel the stock slightly higher in coming quarters. But the biggest potential near-term catalyst for TLRY stock could be short covering.

According to S3 Partners, TLRY stock currently has the second most expensive borrow fee of any U.S. stock at a whopping 136.5%. In other words, short sellers are essentially paying an annual 136.5% interest rate just to bet against Tilray.

And that bet has not been paying off given the stock is up nearly 150% in the past two months.

S3 Partners analyst Ihor Dusaniwsky said Tilray short sellers are in a difficult situation.

“Individual stocks with large mark-to-market losses and/or high stock borrow fees are still prime candidates for short squeezes,” Dusaniwsky said.

About 18.7% of Tilray’s float is currently held short. If the pain gets too unbearable and these shorts are forced to cover, things could get ugly for short sellers. And that would be beautiful for TLRY stock investors.

How to Play TLRY Stock

Unfortunately for TLRY investors, Canopy Growth Corp (NYSE:CGC) just completely deflated the cannabis trade last Friday. Canopy reported one of the most disappointing earnings reports in recent memory, and that’s coming from a CGC shareholder. One of the biggest knocks on cannabis stocks in recent years has been their inconsistency and unpredictability. Canopy’s report suggests investors are in for more of the same for the time being.

At this point, the only thing I can say definitively is that shorting TLRY stock is a very dangerous and expensive game. However, given the uncertainty in the space, I would recommend any TLRY stock investors diversify their portfolio by buying at least three or four other top-tier cannabis stocks as well. Canopy’s report highlights just how much risk there still is in the space. It’s difficult to pick long-term winners and losers at this point. But investors can mitigate at least some of the risk through the power of diversification.

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