Investing in hot cannabis stocks may look attractive, but we recommend extreme caution with these highly speculative stocks

In late September 2018, I appeared on a live broadcast of “The Current,” a CBC radio program, on the subject of the cannabis stock boom. It began with an interview with Rob Armstrong, a real, live GRQ (Got Rich Quick) investor.

Mr. Armstrong was a chef in a northern Alberta oil facility. He heard about the cannabis boom in 2015, as he was already a medical cannabis patient at that time. He felt it offered a great opportunity, so he decided to invest his $37,000 RRSP entirely in hot cannabis stocks. In 18 months, he turned his $37,000 into $1 million.

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After he told his story, the moderator asked what I thought about it. I told her, “Somebody has to win the lottery.” The comparison made sense, at least to me. As a group, lottery-ticket buyers only get back perhaps 25% to 50% of the proceeds of all the tickets that have been sold. The odds may be worse in cannabis-stock boom. Conventional investment safeguards can do little to protect you against that kind of disadvantage.

I wonder if any investors heard the CBC radio program and decided to follow Mr. Armstrong’s lead, by cashing in their life savings and investing it all in hot cannabis stocks. Investors do things like that on impulse in a stock market mania.

In the interview, Mr. Armstrong said he was spending a lot of his time in devising sell targets for his cannabis stocks. However, due to the random factor in short-term stock price movements, sell targets are of little help to investors, even with conservative stocks.

Setting sell targets is apt to be far less helpful with today’s cannabis stocks. The more speculative a stock is, the more the random factors determines its performance.

One good rule is that if you feel you need to set up sell targets for a particular group of stocks you own, you probably should sell most if not all of them. That’s especially true with the cannabis boom. Cannabis stocks started out with high hopes for an explosion in cannabis use and sales, but little if any real value. As a group, they have less real value now than they did a year ago.

Avoid “value traps” in hot cannabis stocks to protect your money

“Value trap” suggests that a stock looks cheap on a statistical basis, but is likely to get much cheaper. It may have an unusually high dividend yield, an unusually low p/e (the per-share price-to-earnings ratio), a low ratio of stock price to book value, or any of several other conventional signs of per-share value.

Any of these indicators can make a stock look like a bargain. But a value-trap stock may be cheap compared to past historical statistics because its stock price has plunged due to heavy selling by insiders or well-informed investors who recognize it has a dismal long-term future.

In the case of many hot cannabis stocks, they have yet to make money, much less pay a dividend or build up any book value. So, like almost all cannabis stocks, it is far from offering “value” in any real sense. It only seems like a bargain now due to how far it has dropped from its year-ago peak.

Hot cannabis stocks have a lot of potential pitfalls

When looking for cannabis stocks to buy–especially cannabis penny stocks–the odds against long-term success are high.

Be aware that many penny stocks are little more than very well executed marketing campaigns. Penny stock promoters–far from offering sound cannabis stocks to buy–will do anything in their power to get their penny stock noticed. These extensive marketing campaigns include emails, TV interviews, podcasts, newsletters and paid sponsorships.

There are also some so-called news sites that will sell sponsorships to penny stock promoters. These are great opportunities for penny stock promoters but not for investors looking for an unbiased opinion on a stock.

Practice caution with your investments and avoid hot cannabis stocks and other highly speculative investments

Many cannabis-stock favourites have gone through a huge downturn since May of this year. Our outlook for cannabis stocks as a group now is that they are vulnerable to further weakness.

We do believe that cannabis legalization will lead eventually to some great business successes. The problem is that only a few of today’s multitude of cannabis stocks will wind up paying off for investors.

Bonus tip: Use our three-part Successful Investor approach to make better stock selections

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news.

How do you think cannabis industry scandals and dropping stocks will impact investors’ faith in the industry?