At the beginning of 2020, things were really lining up for marijuana investors.
Somewhere between 10 and 20 US states were planning ballot measures that would expand access to medical and/or recreational marijuana production and sale in November. Public support was growing as we headed into a Presidential Election year – during which there tends to be larger voter turnout.
Unfortunately, those plans are mostly on hold for now. Collecting voter signatures for ballot issues during a period of self-quarantine and social distancing is all but impossible. Additionally, even with public opinion still heavily in favor of broader legalization, most voters and legislators simply have more important issues to deal with in the current environment.
Business closures, widespread unemployment and the arduous process of reopening the economy are taking center stage and marijuana legalization has temporarily become a bit player.
The Good News
The marijuana industry is arguably in better shape today than it was in 2019, and there are opportunities to buy many strong companies at a fraction of the value they were trading last year.
Many of the regulatory and supply issues that plagued the Canadian market during the first year of legalization have been worked out and hundreds of new retail stores are opening. In December, the second phase of Canadian legalization took effect as derivative products hit the shelves for the first time, producing a big sales boost.
There has been progress in the US as well, with the House of Representatives passing a bill that would allow banking access to marijuana companies and on the verge of passing a much wider legalization bill. Though those pieces of legislation face an uncertain fate in the Senate, it’s clear that the regulatory environment is shifting in favor of legal marijuana in the US.
Most US jurisdictions declared cannabis sales an “essential” business during the shutdown and sales have been booming. In fact, thanks to social distancing standards, it appears that many consumers who might have otherwise done business in the illicit markets have instead been patronizing licensed retail outlets or using delivery services.
In an unexpected but fortunate twist, the shutdown that has been painful for so many businesses has actually been positive for the marijuana industry.
It probably shouldn’t come as too much of a surprise that when millions of people find themselves largely confined to their homes with their work responsibilities reduced or eliminated, the demand for both THC and CBD-based cannabis products increased.
More . . .
National Reopening Heralds Pot Stock “Gold Rush”
Legalized marijuana, with almost unimaginable profit potential, has swept over all of Canada, down through 33 states plus D.C. Mexico is finalizing plans to legalize pot for both medicinal and recreational purposes.
While the pandemic subsides, global sales are climbing fast and this new industry is predicted to skyrocket from $17.7 billion in 2019 to an expected $73.6 billion by 2027.
Not since the Repeal of Prohibition in 1933 has there been such a release of pent-up demand.
How can you take advantage?
Now let’s take a quick tour through the history of publicly traded cannabis stocks, and also take a look at where the opportunities currently lie for investors in this exciting space.
Early Booms and Busts
As US states and other countries started to allow the medicinal use of marijuana 20 years ago, companies sprung up to fulfill the demand for cannabis products to be produced, distributed and sold to patients. The inconsistent patchwork of rules and regulations in various jurisdictions meant that most of these organizations were small, local businesses.
There were some forward-thinking businesspeople who imagined a day when cannabis would be a commercially viable product – both for the medical and recreational markets – and who began to build businesses with a wider reach, many of which would become the publicly traded companies of today.
As public opinion on the use of cannabis shifted and the trend toward legalization began to pick up steam, hundreds of those companies began trading “over-the-counter” (OTC). Investors could purchase equity shares, but they were not listed on major exchanges. Nor were they subject to the financial reporting requirements and strict oversight that most investors have come to expect.
The vast majority were “penny” stocks, with share prices of just a few cents (or less), and often dubious business prospects. Most of them no longer exist and the investors who envisioned big profits as a result of being in early lost the entire value of their investments.
New industries tend to be prone to boom and bust cycles and marijuana is certainly no exception.
The Tide Begins to Turn
In the US, 11 states have legalized the production and sale of recreational marijuana and 34 allow medicinal use. Additionally, the entire country of Canada legalized recreational use in 2018. There are now large, well-capitalized companies operating in both countries and many of them trade publicly.
But there are significant limitations on how an investor might participate.
Major US stock exchanges – quite sensibly – will decline to list any companies who are engaged in illegal activity, and since marijuana remains illegal at the federal level in the US, that means no companies who deal directly with marijuana inside the country are traded on the NYSE or NASDAQ.
Currently, the marijuana companies an investor can purchase on those exchanges either operate only in other countries where marijuana is completely legal – most notably Canada – or are US companies that provide ancillary services to the marijuana industry but don’t handle the products themselves. There’s literally even an industry euphemism for that type of business – companies that “Don’t touch the plant.”
Many more companies are now operating in a legal grey area in which they are virtually certain of their immunity from criminal prosecution because they are following the laws of the state in which they do business, yet cannot use traditional banking and credit card services or deduct many expenses when calculating taxes owed, and also cannot list their shares on the major exchanges.
During 2018 and the first few months of 2019, investor interest in marijuana stocks caught fire and most of the publicly listed stocks in the industry saw huge increases in share value, with more than a dozen companies exceeding a billion dollars in market capitalization.
It was definitely another boom.
Because the number of stocks available was so small, and the potential market for cannabis sales was so large, investors quite logically assigned very rich valuations to those companies, expecting that they would soon be sharing an enormous windfall.
Classic Growth Stock Conundrum
If you see a company that has the potential to exponentially grow revenues and earnings, but is still in the growth stage in which they are spending heavily on expansion, you have to take a leap of faith to buy early.
But if you wait until the money is rolling in, the share price will likely have already risen to reflect a more traditional valuation and the opportunity for huge gains will be gone.
If you buy and you’re wrong however, the losses can add up quickly.
While many well-run companies carefully explained the (potentially temporary) factors that prevented them from posting better results, nervous investors quickly grew impatient.
Ready for Upswing?
The uncertain legal status of marijuana in the US has kept most big institutional investors on the sidelines. Institutional ownership tends to smooth out price volatility in a stock because professional investors managing billions of dollars tend to plan their trades carefully and aren’t easily swayed by rumors or emotion.
Institutions enter and exit trades gradually, buying and selling their positions in a controlled manner rather than loading up or dumping their shares all at once.
The large retail-investor ownership of the marijuana stocks helped them tumble quickly once sentiment changed. The same forces that took those stocks up like a rocket conspired to force them down just as quickly.
The ETFMG Alternative Harvest ETF (MJ) lost 56% of its value between March and December of 2019 and many individual stocks lost 70% or more. The down move was exacerbated by large short interest as professional traders preyed on the panic in the sector, selling stocks short into the crash. 2020 didn’t start very well either, but the situation is changing rapidly.
In a “risk-off” environment precipitated mostly by fears of the spread of the Covid-19, speculative investments tend to be the first assets sold, and that included cannabis stocks.
But in the rally off the March 2020 lows, those same stocks have outperformed the broad markets.
Any investor who avoided marijuana stocks over the past two years would be well served to take another look. Right now could well be the opportunity you’ve been waiting for.
There was a significant shakeout in the industry and investors were fearful that the once-promising profit potential would not be realized. Those concerns turned out to be overblown.
“Fear” is the operative term. One of the world’s most successful investors, Warren Buffett, famously said “Be fearful when others are greedy and be greedy when others are fearful.” Now the time is right to make your move.
How to Pursue the Big Profits
At Zacks we’re monitoring political developments very closely as well as tracking individual stocks.
This space looks to EXPLODE from $17.7 billion in 2019 to $73.6 billion by 2027.¹ Yet only a few growers, pharmaceuticals, financial firms, suppliers – both established and start-ups – are the true innovators and offer exceptional profit potential.
So if you don’t want to devote the constant attention and painstaking analysis to find these often little-known tickers, we can find them for you.
Author: David Borun
Source: Zacks: Is it Time to Buy Cannabis Stocks?