What to consider before investing in cannabis stocks, and four cannabis stocks to watch.
The cannabis industry is experiencing many changes that are attracting a lot of investor interest in investing in cannabis stocks. However, it’s important to realize that these stocks are speculative stocks with momentum, and not true growth stocks at this point in their development.
On April 13, 2017, the Canadian federal government introduced its bill to legalize recreational marijuana use, with the hope that new legislation will be in place by October 17, 2018. The new law will likely let adults over the age of 18 to carry up to carry 30 grams of marijuana, and households will be allowed up to four plants.
With the legalization of marijuana, and the increase in marijuana production, there will be an even bigger increase in investor interest in cannabis stocks.
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Is investing in cannabis stocks a long-term investment (growth stock) or short term (momentum stock)?
It’s common for investors to confuse growth stocks with momentum stocks.
Growth stocks are long-term investments. They can be well-known stars or quiet gems, but they share the common trait of growing at a higher than average rate within their industry, or within the market as a whole.
Like growth stocks, momentum stocks are moving highly in the market, as you’ll find most cannabis stocks are. But unlike growth stocks, the overall goal from momentum trading in cannabis stocks is to profit from shorter-term trades. Momentum investors are particularly keen on the so-called “positive earnings surprise.” That’s when a company outdoes brokers’ earnings estimates.
They view a “negative earnings surprise”—lower-than-expected earnings—as a sell signal. They use a variety of computerized formulas to make buy and sell decisions, but all come down to “buy on strength and sell on weakness.” So they tend to pile into the same stocks all at once, and the gains that follow are something of a self-fulfilling prophecy.
The trouble is that when the cannabis stock’s rise falters, momentum investors also try to get out as a group, but there are never enough buyers. That leads to violent price fluctuations in the stock’s price, something that could happen early and often in cannabis stock investing due to the sudden rise in popularity.
As you probably know, several U.S. states have decriminalized or legalized cannabis use and have begun authorizing legal production and sale of the plant. In Canada, marijuana has been legal for medical use for some time, and the government is developing a plan to allow for some legal form of recreational use. As a result, we are increasingly asked about Canadian cannabis stocks.
This change in the law is bound to lead to a shift in current and future cannabis production, from the underground economy to the legal economy, where it can be regulated, taxed and invested in. Tax revenues are already starting to roll in, but we haven’t found any Canadian cannabis stocks worthy of investment. So far, many of what we’ve seen are stock promotions.
Stock promotion is a take-the-money-and-run type of business. Most successful entrepreneurs value their reputations, and want to build a profitable, sustainable business that can pay off for investors. So they generally go into some other line of work, and stay out of stock promotion. Right now, cannabis stock investing is a risky area.
Read more about speculative and cannabis stocks.
How risky is cannabis stock investing?
While the cannabis industry now has a number of established producers, in the early days of de-criminalization we saw many highly speculative “pot-of-gold” penny stock promotions. These typically arise in new industries. We advise staying out of stock promotions of cannabis stocks or anything else. They attract the wrong kind of people.
There are very low barriers to entry for new medical cannabis producers. If the market grows large and profitable enough, big producers, including tobacco companies, will likely enter the market and take sales away from small growers. Regulation of cannabis is subject to constant change and uncertainty and there are no cannabis stocks we currently recommend, however here is a short list of the most well-known ones for your radar.
Instead of speculative cannabis stocks, learn how to invest in real growth stocks
By definition, growth stocks are companies that have above-average growth prospects. They are businesses whose earnings growth has been above the market average, and is likely to remain above average. Most pay small dividends or none at all. Instead, they re-invest their cash flow in the business, to promote their growth. This is something the cannabis industry is far from achieving at this point.
Although growth stocks can be highly volatile, much like cannabis stocks, they often make good long-term investments when you invest in the right company. To find a growth stock worth investing in, watch to see if it consistently grow at higher-than-average rates.
As an investor, do you agree with cannabis legalization for recreational use?
This article was originally published in 2017 and is regularly updated.
Comments
Shiv
There are ways to play Cannabis without investing in pure play. For example, Scott’s Miracle Gro (SMG), AbbVie, and others.
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There are ways to play Cannabis without investing in pure play. For example, Scott’s Miracle Gro (SMG), AbbVie, and others.