Cannabis Stocks 101: What to Know Before Investing
March 7, 2017
March 7, 2017
According to the 2016 Marijuana Business Factbook, the cannabis industry could potentially pump up to $44 billion annually into the US’s economy by 2020, provided that current trends continue. Considering that those figures are up from $17 billion in 2016, it’s not surprising to see how the cannabis market might look appealing for early investors.
Though a minority of companies have managed success across state lines, the majority of cannabis businesses remain small, instigated by enthusiastic individuals with sufficient boldness to go against the grain while, bizarrely, swimming with the current trends of legalization. However, despite the preponderance of these entrepreneurs believing in the cause of their movement, their sheer tenacity doesn’t guarantee the business savvy that it takes to overcome the numerous obstacles that currently exist. Nonetheless, many view this as the emergence of a business that is on the cusp of becoming a massive economic force.
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The cannabis industry is incipient, especially in terms of stocks, with most companies too small to trade on a federal exchange. There remains a problem for potential investors in the industry: the Financial Industry Regulatory Authority (FINRA). As long as cannabis is classified as a Schedule I substance, Wall Street’s regulator-in-chief isn’t going to approve an S-1 filing from a cannabis company wishing to go public.
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This adds a curious “while the cat’s away, the mice can play” dimension to the investment situation. Regulatory ambiguity might be keeping more “professional” money out of the industry, but it’s creating room for smaller investors to establish a foothold. Penny stocks, or “pink sheets,” are where most cannabis securities are traded. As this occurs outside the federal exchanges, regulation is not as tight, meaning due diligence falls squarely on the shoulders of investors.
Let’s explore the current state of marijuana stocks before speculating on how that might change, the reasons to invest, and what simple considerations prospective investors should take.
What Are Penny Stocks?
Between your spasms of laughter, you might have asked yourself, “What in the hell are penny stocks?”
Despite their name, these types of stocks rarely cost a penny. Basically, penny stocks refer to securities issued by small companies that trade at less than $5 per share. As you might have picked up from the shenanigans portrayed in Scorsese’s 2013 film, investors tend to look upon penny stocks as a post-apocalyptic, Mad Max-type free-for-all where financial cowboys can ride roughshod over the uninformed.
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For the risk-averse, low cost stocks do exist on exchanges like NYSE and Nasdaq but aren’t considered “penny stocks.” These exchanges have strict listing requirements and tend to be more reliable. True penny stocks trade on listing services like OTC Bulletin Board and Pink Sheets. Pink Sheets is a system that provides investors with quotation information on stocks that are registered with it.
While Pink Sheets is just a quotation publisher, OTCBB maintains some listing requirements and so possesses added legitimacy. Unlike OTCBB, however, Pink Sheets isn’t registered with the Securities and Exchange Commission (SEC) and doesn’t enforce any listing requirements, making these stocks much riskier.
Beware of OTC Cannabis Stocks
“Beware of strangers and hitch-hiking ghosts”–that’s what my mother always said. She’s a common-sense lady. Substantially more often, she’d warn against over-the-counter (OTC) stocks. So, needless to say, investors should be careful.
There are very real risks associated with investing in public cannabis companies. Companies offering OTC stock do so because they can’t meet the stringent financial requirements of major stock exchanges. As mentioned, OTC markets can be riddled with unscrupulous stock promoters attempting to separate investors from their money.
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Overall, there will be an abundance of losing investments in the marijuana marketplace in the coming years, so expect an inevitable shakeout. Investors would be wise to consider their options carefully. The risk associated with these stocks means that they might be best suited for the more aggressive, seasoned investor. If you’re more conservative in your approach, you might be better off playing the waiting game to see how things transpire. Those worried about plunging their money into public companies that legally grow and sell cannabis might feel safer dealing with one of the industry’s many ancillary businesses.
Money for Old Rope
Considering the significant risk involved, why would anyone want to throw their money away on penny stocks? The answer is volatility and the potential for immense reward. Penny stocks are prone to violent fluctuations, and there are an untold number of eternal optimists out there who believe that they’ll come out on the right financial side. Companies that can successfully make the jump from penny to power stock are rare, but streetwise investors have managed to rake in gains of over 1,000% within a short space of time.
The trick lies in finding the right opportunity at the right time. Like any other stock, you can purchase shares of a penny stock through your normal stockbroker regardless of whether or not it’s listed on a major exchange. Remember though, there’s a reason brokers and regulatory bodies go to such lengths to make sure that you’re not blindly investing in penny stocks; flimflam men are out there. Believe it or not, this includes many marijuana companies, some of which exert more effort marketing their stock than their products.
If it seems that the prospect of getting insane money for old hemp rope is too good to be true, maybe you should step back, take a deep breath, and run the other way while keeping your hands in your pockets. (It’ll look funny, but it’s the safest option.)
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Where Is the Cannabis Stock Market Going?
As demonstrated by the recent elections, Americans are becoming more enthusiastic in their approach towards medicinal marijuana. According to the National Organization for the Reform of Marijuana Laws, or NORML, eight out of ten Americans support it. The volume of cannabis stocks listed on the Nasdaq spiked ahead of the election, with some stocks rising as much as 12%. Voters decided that four new states (California, Massachusetts, Nevada, and Maine) will allow full legalization (adult use) of marijuana while four other states (Florida, Arkansas, North Dakota, and Montana) approved medical use.
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Interest in cannabis-related stocks has risen from penny stocks to Nasdaq-listed equities. Perhaps unsurprisingly, much stock may have been initially undervalued because investors were hesitant and the adoption of drugs produced by cannabis-focused biopharmaceutical companies was low. The current options for mainstream investors in this area are limited to a handful of companies listed on the Nasdaq, including GW Pharmaceuticals (GWPH), Insys Therapeutics (INSY), Cara Therapeutics (CARA), and Zynerba Pharmaceuticals (ZYNE).
A report from Merrill Lynch outlines how the $2.9 billion medical marijuana industry might double in size if other states legalize the use of cannabis in medicines and if FDA-approved cannabis products catch on in popularity. Still, investors are very cautious as to whether these stock prices are sustainable; they fear there may be a correction on the cards after the election.
Reasons to Invest in Marijuana
To put it bluntly, the shift toward legalization is the strongest reason to want to invest in cannabis. Public opinion is demonstrably trending in this direction. Even re-scheduling cannabis as a Schedule II substance would be a huge catalyst for marijuana stocks.
Not surprisingly, as a direct correlation to increased legalization, the cannabis industry is growing rapidly. Analysts from the ArcView Group estimated that cannabis sales in the United States jumped 17 percent to $5.4 billion in 2015, and sales are expected to grow by 25 percent this year to $6.7 billion. They believe that by 2020, legal cannabis sales in the United States may hit $21.8 billion. That’s a lot of revenue and, if there’s anything governments love, it’s more tax revenue.
Those figures also represent a lot of work. Cannabis’s journey towards the mainstream is giving birth to jobs, new business opportunities, and creating a ripple effect across the country. What’s not to love about that?
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Financial and economic considerations aside, legalization and industry growth have potentially game-changing medical use implications. As a heroin epidemic sweeps the country, much-needed research is going into the medical applications of cannabis as a painkiller. This isn’t even taking into consideration the early research suggesting cannabis can treat a tremendous variety of diseases and illnesses. Finally, there’s the incredible breadth of potential investment opportunities. The industry is comprised of all sorts of business types, from technology to processing, from production to research, and from agriculture to retail. Forgive the pun, but the weed game has plenty of room for growth.
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Despite the lack of absolute certainty, there is no denying the potential of the cannabis industry. Unfortunately, many companies are trying to attract investors by simply wrapping themselves in a red, yellow, and green flag, with a cannabis leaf, the Lion of Judah, and 4/20 printed on it. How can investors make sure they’re not being sold a pig in a poke, so to speak?
It’s always of paramount importance to be cautious. As already outlined, beware of potential scams and maintain a healthy skepticism when evaluating business models. Always do your homework; due diligence is essential, especially in a nascent industry subject to a lot of uncertainties. Remember that companies involved with the cannabis product itself are still illegal according to federal laws, despite being legal in some states.
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Likewise, it’s crucial to consider the investment horizon and market. For example, approximately 14 million Americans currently use cannabis on a regular basis. While that’s a lot of people, it’s not terribly likely that legalization will drastically create more adult-use consumers. It’s a capped market that could potentially become saturated with competing products and services.
You’ll need to embrace auditors and make use of well-qualified professionals to review contracts before you enter into them. SEC financial filings by companies can offer a hidden store of insight, but that insight only matters if it’s been independently audited by accountants. If a company has changed its name four times in five years, that’s a red flag signaling a potentially terrible life decision.
Finally, never forget that the industry is still developing in conjunction with regulations and ever-changing legislation; deviations are to be expected. Nothing is a forgone conclusion in this industry, which makes investing here rather riskier than usual, but also incredibly exciting and potentially rewarding.
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