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Investment Outlook

Speculation about a “bubble” in cannabis stocks may be exaggerated, but holders of marijuana stocks will benefit from learning our sell-half rule.

Deciding when to sell is one of the trickiest parts of investing. Our genes program us to run from danger, and every day the media brings new reasons to sell. But if you sell too often or too quickly, you’ll sell a lot of your best choices way too early, and you’ll never make any serious profits.

Share prices for many Canadian marijuana stocks have moved down since the legalization of recreational cannabis on October 17, 2018. Even so, they are still up considerably since mid-2016.  For example, the market cap (the value of all shares outstanding) of Canadian leader Canopy Growth is a whopping $11.4 billion.

These high valuations bring to mind a term that has become part of the average investor’s vocabulary—“bubble.”

When you label a particular investment area as a “bubble,” you are saying that it’s so over-priced, and has generated such high investor expectations, that current buyers are bound to lose money. That situation does occur from time to time.

The market for recreational marijuana is huge. According to estimates from Statistics Canada, about 4.9 million Canadians used cannabis and consumed more than 20 grams of marijuana per person in 2017, spending a total $5.6 billion on the product. Legal sales could reach as high as $6.5 billion or more by 2020.

Shares of many marijuana stocks may rebound or even move to new highs as momentum traders buy the widely followed stocks on the latest upswing. However, even considering the size of the potential recreational cannabis market, many Canadian producers still have extraordinarily high market caps.

That means they need to capture a big part of the legal market to justify their current stock prices. If revenues don’t rise considerably—and quickly—their stock prices could be very vulnerable.

Consider our “sell-half” rule

You should be quicker to sell aggressive stocks than conservative stocks. With aggressive stocks—and cannabis producers certainly fall into that category—it often pays to apply our sell-half rule. That’s when you sell half of a stock that doubles in price.

But above all, we feel that to cut their risk, most investors should invest the bulk of their portfolios in high-quality stocks—and keep aggressive stocks to a smaller part of their holdings.

That’s at the heart of our approach to investing. It revolves around the fact that well-established companies tend to do well for investors over long periods. And, even when they underperform, these companies tend to retain much more of their value than less well-established companies. That’s why our first rule of successful investing is that you should put most if not all your investment funds in well-established companies.

Our second rule of successful investing is that you need to diversify across most if not all of the five main economic sectors. There is an unpredictable, random element in investing that you can’t get away from. By spreading your money out across the five sectors, you automatically avoid over-indulging in a sector that is headed for a big fall. Moreover, this rule forces you to invest in sectors that are currently out of investor favour. That’s a good thing to do, providing that you stick with well-established companies. That’s because the five sectors tend to leapfrog each other over long periods, and out-of-favour sectors have a way of abruptly returning to popularity. If you only buy after they have returned to popularity, you will occasionally miss out on some extraordinary gains.

Our third rule is to downplay stocks that are in the broker/media limelight. That’s because these stocks tend to develop exaggerated investor expectations. When they fail to live up to those expectations, declines can be steep.