Are You Thinking About Investing In Cannabis Stocks?

The marijuana industry is the hottest thing since sliced bread, and marijuana stocks are thriving as a result. “Green rush” is a phrase that’s been used quite a bit lately. People use the expression to refer to the explosive growth in the legal marijuana industry. Some of that growth has stemmed from a wave of legalization of medical marijuana, while some of it has also come from a smaller number of U.S. states that have legalized recreational use of the drug.

Anytime there’s a rush in any industry, it presents opportunities for investors to profit. Unfortunately, these rushes also present just as many opportunities for investors to lose money. There are plenty of reasons you shouldn’t buy marijuana stocks.

Many of them are extremely speculative. Most marijuana stocks claim stratospheric valuations. Many companies in the marijuana industry are losing money. Selling marijuana remains illegal under U.S. federal law, which means the federal government could lower the hammer in states that have legalized marijuana any time it chooses to do so. The bottom line is that investing in marijuana stocks is very risky. Profiting from the green rush is possible, though.

However, there is one really good reason to buy marijuana stocks. In fact, I’d say it’s the single most compelling reason to buy marijuana stocks right now. What is it? One word: growth.

Growth up north: One place that growth for marijuana stocks seems assured is Canada. Medical marijuana has been legal in Canada since 2001. There are over 40 authorized licensed providers in the country that grow and sell marijuana to be used for medical purposes.

Growth in the U.S.: National legalization of marijuana doesn’t appear to be likely in the U.S. for a while. However, 29 states have legalized medical marijuana, with eight states plus the District of Columbia legalizing recreational marijuana. The U.S. marijuana industry is highly fragmented right now, with lots of small players. It’s possible the old adage that a rising tide lifts all boats will prove true. Perhaps growth of the U.S. marijuana market will mean that many of the small companies now will grow much larger.

Enormous growth overcomes a lot of the negatives associated with investing in marijuana stocks. Companies that are currently speculative could be respectable. Seemingly ridiculous valuations seen now could be justified. Losses could turn into big profits. Significant risk could be converted to significant rewards. It’s important for investors to understand, though, just how much growth will be required to make all of that happen. Perhaps the best way to profit from growth in the marijuana industry is to look at the market from a different angle. All of those marijuana growers will need supplies to be successful.

Rules for Investing in Marijuana Stocks

Forget the hype

Above all else, forget the hype about marijuana stocks. You’re probably not going to become the next “marijuana millionaire,” no matter what some marketers on the internet might tell you. There’s nothing magical about marijuana stocks that automatically makes them better investment candidates than other stocks.

When you buy a marijuana stock, you’re investing in part of a company. The purpose of that company is the same as others that are publicly traded — to provide products and services to customers and to create shareholder value. If you focus less on the allure of the product and more on the potential for the business and the industry in which it operates, you’ll be much better off.

Understand the risks

Every company, every stock, and every industry comes with its own set of risks. It’s critical that you understand the risks for marijuana stocks and the marijuana industry in general before investing.

What are those risks? U.S. marijuana growers face the possibility of a crackdown by the U.S. government. After all, federal laws still prohibit the sale and use of marijuana, regardless of legalization by individual states. Canadian marijuana suppliers don’t have to worry about that particular threat. However, the potential exists that something could derail efforts to legalize recreational use of marijuana in the country.

Also, many marijuana stocks have tiny market caps and are traded over the counter, rather than on public stock exchanges. There are significant risks with such stocks, including lack of liquidity and limited information, which can impact your ability to make wise investing choices.

Identify the leaders

It’s smart to pick stocks of companies that are leaders in a given industry. That’s especially true for the marijuana industry, which could be ripe for commoditization.

Sometimes, leaders might be hard to find. The U.S. doesn’t have one or two dominant, publicly-traded marijuana growers. Instead, the market is spread across many smaller players. It could be helpful to take a broader perspective and look to stocks like Scotts Miracle-Gro (NYSE:SMG). Although Scotts isn’t technically a marijuana stock, the company is definitely a leader in providing hydroponics and lighting supplies to the marijuana industry.

Evaluate prospects realistically

Canopy Growth stock trades at 35 times sales. MedReleaf shares trade at 19 times sales. Those multiples reflect expectations of enormous growth baked into the stock prices. Some marijuana stocks are priced even more expensively. You need to evaluate the future prospects for marijuana stocks realistically, making sure you follow rule No. 1 and forget the hype.

How can you evaluate a stock’s prospects? First, look for reputable data about potential growth for the industry. For example, accounting and consulting firm Deloitte projects that the Canadian recreational marijuana market could generate between $4.9 billion and $8.7 billion. Deloitte is a respected company, and its estimate is based on survey data about how many Canadians are likely to use recreational marijuana, combined with publicly available data on sales volume from jurisdictions where recreational marijuana is already legal (for example, Colorado) and current market prices in Canada.

Second, determine how likely a given stock will be to capture a significant market share. This requires some guesswork. For example, if you think Canopy Growth can capture 10% of the Canadian marijuana market and use the lower end of Deloitte’s range, the company could achieve roughly $500,000 in annual sales. Is there room for Canopy Growth stock to move higher from its current market cap of $1.4 billion under this scenario? Probably so. But if you think the company won’t get nearly that significant of a market share or if you question Deloitte’s projections, the stock might not be a good pick.

The rush to get in on the marijuana craze has created hundreds of startups, but the odds are that many of these will fail. The winners so far are established companies that are adding marijuana to their focus. However, even some of these winners have seen drops in their stock prices lately.

Marijuana is showing potential for medical uses, and companies that are developing medical applications for the plant stand to gain in the marketplace.

Marijuana stocks that have the potential to make significant gains

AbbVie Inc.

AbbVie a pharmaceutical company that is ahead of the pack because it has a cannabis-based drug on the market. The FDA approved Marinol, which helps alleviate nausea or vomiting for chemotherapy patients. The drug also helps AIDS patients who have lost their desire to eat. It is important to note that Marinol is not AbbVie’s flagship drug. In fact, it is not even the company’s biggest seller.

The Scotts Miracle-Gro Company

An interesting way to play the marijuana boom is Scotts Miracle-Gro. Known for its lawn and garden-care lines, the company is developing products for cannabis growers and also several pesticides for use on marijuana plants.

Corbus Pharmaceuticals Holdings, Inc.

This stock has seen some dramatic ups and downs over the past year. Hopes rise and fall for its marijuana-based drugs, which are in clinical trials. Resunab, which is designed to treat sclerosis, has had promising trials. The stock has tended to dip just before trial results are announced and then rally when the results are positive.

INSYS Therapeurtics, Inc.

Although this company markets many non-cannabis drugs, it is in the process of developing a synthetic cannabis drug to treat childhood epilepsy. INSYS is working on a spray technology to deliver pharmaceutical cannabinoids.