Should you invest in marijuana stocks? – The fool

You've probably seen first-hand the impressive growth in public support for marijuana, as evidenced by the growing number of states that have legalized the drug for medical or recreational purposes. You have probably heard about the huge gains that marijuana stocks have generated over the past two years. You might also be aware of predictions regarding the size of the marijuana industry, including a recent projection that the US marijuana market could reach $ 22 billion by 2022.

If all these developments lead you to consider investing in marijuana securities, you are not alone. An increasing number of investors have bought shares of marijuana shares in anticipation of huge returns. But should you invest in marijuana stocks? Here's what you need to know to make an informed decision.

What is marijuana?

Before investing in a business, it makes sense to understand the basics of the company in which the business operates. For marijuana stocks, that means first getting to know marijuana or cannabis.

There are two main chemicals in the cannabis plant, called cannabinoids, that investors should mostly know about. Delta-9 tetrahydrocannabinol (THC) is the main psychoactive ingredient in marijuana. Cannabidiol (CBD) is another important cannabinoid that has been shown to have therapeutic effects.

These two ingredients have been at the forefront of the fight against marijuana. The United States, as well as many other countries around the world, prohibit the use of marijuana at the federal level, mainly because of the disruptive effects and potentially addictive attributes of THC. However, the potential therapeutic benefits of CBD have led 30 states and US countries, including Canada and Germany, to legalize marijuana for medical purposes. In addition, nine US states and the District of Columbia now allow the legal use of marijuana for recreational purposes. The opening of the recreational cannabis market in Canada is scheduled for October 17, 2018.

Although the legalization of marijuana is still somewhat controversial, public support for legalization in the United States and in other countries has continued to increase. For example, a recent survey by the Center for American Progress, a progressive research and advocacy group on public policy, found that 68% of Americans support the legalization of marijuana – a record level of support. Forty percent of respondents strongly support the legalization of the drug.

The spread of the legalization of marijuana has created a flourishing industry. Companies have been created to serve all areas of the growing industry, from cultivation and cultivation of cannabis (or supply of services to producers) to the development of cannabinoid prescription drugs.

The case for investing in marijuana stocks

Many companies in the cannabis industry have chosen to "make themselves known", making their shares available for sale on public markets, in order to generate cash to fuel additional growth. This growth potential is the most compelling reason to consider investing in marijuana stocks.

Canada's vote earlier this year to legalize recreational marijuana has drawn investor attention to Canadian marijuana stocks. Arcview Market Research and BDS Analytics predict that marijuana sales in Canada will rise from about $ 600 million last year to $ 5.4 billion in 2022. This is a compound annual growth rate of more than 55% .

Germany has legalized marijuana for medical purposes in 2017. The country's cannabis market could reach $ 1.6 billion by 2022, according to Arcview and BDS Analytics, against just $ 9 million Last year. This projected growth makes Germany not only the largest international marijuana market outside of North America, but also the fastest growing marijuana market in the world.

But the biggest price of all is the United States. Even with the rapid expansion of marijuana markets in Canada, Germany and elsewhere, the United States will likely account for almost three-quarters of total cannabis revenue in four years.

Overall, the global marijuana market could more than triple from 2018 to the end of 2022. There are likely to be several big winners to this meteoric growth. Investors who choose these winners accurately should be ready to achieve fantastic returns over the next few years.

The case against investment in marijuana stocks

There are two main arguments against investing in marijuana stocks. One is the risk that projected growth does not materialize. Another is that the growth potential of marijuana companies can already be reflected in the high valuations of their stocks.

Will the global growth of marijuana markets really happen? Maybe, but it's important to remember that marijuana remains illegal at the federal level in the United States. And the United States is the 800-pound gorilla in the global marijuana market.

There is a significant chance that the US government will continue to crack down on marijuana-related companies in states that have legalized the drug. US Attorney General Jeff Sessions is a long-time opponent of the legalization of marijuana. In January 2018, the sessions overturned the Obama administration's policies that largely prevented federal agencies from intervening in states that had legalized marijuana.

Sessions is not the only person who is opposed to the expansion of the US marijuana industry. The Bureau of National Drug Control Policy has launched a committee engaged in "a secret war against weeds," according to a recent report from Buzzfeed's online news site. This committee would have asked federal organizations to submit "data demonstrating the most significant negative trends" regarding the use of marijuana as part of an effort to derail support for the legalization of marijuana .

Even if the government does not intervene, the black market is another potential threat. California's legal recreational marijuana market opened in January 2018. However, sales grew much more slowly than expected, largely because of the availability of marijuana on the black market at lower prices.

Investors should also note that major Canadian cannabis companies are not going to set up large operations in the United States as long as federal anti-marijuana laws are in place. This limits their total addressable market. Although many expect Canada 's demand to be higher than the initial supply, it is likely that within a few years there will be an overabundance of supply. cannabis in the country. When that happens, Canadian marijuana stocks could be in trouble if international markets for medical marijuana can not absorb all excess capacity.

Of course, it is possible that the global marijuana market is growing as fast as expected. Are marijuana stocks guaranteed, if that is the case? Not necessarily. The anticipation of a huge growth is reflected in the stock prices of most marijuana stocks. For example, the top three Canadian marijuana titles currently have price-to-sales ratios of 159 or higher. Given that the price-to-sales ratio for any other industry is around 8, marijuana stocks have clearly taken into account considerable growth. This alone could be enough to deter investors from many companies.

In addition, some investors may prefer to avoid marijuana stocks simply because they do not like buying "sin shares" – shares of companies whose activities are focused on a particular product, service or product. industry that some consider immoral or unethical. If you are in this category, you are in good company. The legendary investor Warren Buffett refused a few years ago the opportunity to buy a major tobacco company because he did not want investments in tobacco to be stigmatized.

What to look for in marijuana stocks

If you think the arguments in favor of investing in marijuana stocks outweigh the risks, it's important to think about marijuana stocks as you would any other action you plan to take. 39; buy. One of the most important things to do is to check the management team. Ideally, executives will have a history of success and a good ethical and professional reputation.

While marijuana is a fast-growing industry, some companies are better placed than others. Look for the business strategy of a company and compare it to peers. For example, a Canadian marijuana producer that focuses almost exclusively on the Canadian domestic market is less likely to grow than its rival with extensive international activities.

Make sure to review the financial status of each marijuana stock you consider. Many companies in the cannabis industry are not yet profitable. This is not an obstacle if they have a sufficient cash position (including cash, cash equivalents and short-term investments) to fund operations in the future – and they have a solid plan to achieve the profitability.

Investors should look for certain factors specific to certain marijuana stocks. Look at the cost structures for marijuana growers. Companies that can grow cannabis cheaply will be better able to compete on price. For cannabinoid-based biotechnologies, identify potential competitors, including other biotechnologies that contain drugs other than cannabinoids on the market or in development.

Last but not least, check out the stock valuations. Parameters based on historical performance, such as the price-earnings ratio, are unlikely to be as useful for valuing most marijuana stocks as much of their value is tied to expectations of future growth.

A useful measure for evaluating marijuana growers is the ratio of the value of the production capacity of the company. The enterprise value represents the total value of a company, taking into account cash, debt and other criteria. Production capacity is the annual expected short-term capacity for growing cannabis in kilograms. The division of these two values ​​gives you a measure that allows you to compare stock assessments of marijuana growers. The main disadvantage of this ratio is that it is only an evaluation metric for other marijuana stocks. It does not tell you if a stock is expensive compared to stocks in other industries.

Strategies for investing in marijuana stocks

Whether you invest in marijuana stocks depends on your personal investment style, especially your tolerance for high risk levels. The aggressiveness of an investor is essential in determining the strategy to follow for investing in marijuana securities. Here are six investment alternatives in the cannabis industry that reflect three different investment strategies.

Data source: Yahoo! Finance. N / A = not applicable. Data as of September 14, 2018.

To help you better understand the thinking process to follow when considering each of the three marijuana investment strategies, we will briefly discuss each strategy and the actions listed in the chart that fit the strategy.

Invest in pure-play marijuana stocks

Pure marijuana stocks are stocks of companies that derive most or all of their income from marijuana products or services. The return potential of these equities is very high because of the growth prospects mentioned above. However, the potential risk for these securities is also very high due to the possibility that growth may not meet expectations or that growth may not be greater than what is already profitable for stock prices. Canopy Growth and GW Pharmaceuticals are two examples.

Canopy growth: It is the largest Canadian marijuana producer in terms of market capitalization. The company has a strong management team with solid experience in the industry. Canopy should be in a good position to take advantage of the Canadian market for recreational marijuana starting in October. The company is also active in several international marijuana markets, particularly in Germany.

Although Canopy Growth is not profitable, it is mainly because the company is investing in the expansion of its production capacity and its global operations in anticipation of increased demand. The company has plenty of cash to grow with a $ 4 billion investment from Constellation Brands announced in August.

The price / sales ratio of Canopy (159) shows that the stock has an astronomical valuation because of its historical performance. Although Canopy shares are much more expensive than they were at the beginning of 2018, they still compare well with most of their peers using the Enterprise Value / Productive Value indicator discussed earlier. .

GW Pharmaceuticals: This company received approval from the US Food and Drug Administration earlier this year for the first herbal cannabinoid drug, Epidiolex, used in the treatment of Dravet syndrome and Lennox-Gastaut syndrome, two rare forms of 'epilepsy. Biotechnology also has another cannabinoid-based drug, Sativex, approved in several countries outside the United States.

GW is by far the largest cannabinoid-based biotechnology with a market capitalization of nearly $ 4 billion. The value of the stock depends on the performance of Epidiolex. Some are pessimistic about the prospects of the drug against epilepsy. However, several analysts are optimistic about Epidiolex's commercial hopes. The market research company EvaluatePharma predicts that Epidiolex will be one of the 10 most important new drugs launched in 2018, with a business turnover of around $ 1 billion. in 2022.

An advantage for investors buying GW Pharmaceuticals is that it does not run the risk of federal marijuana suppression, as the company has followed the FDA's standard approval process. However, GW could face competition for Epidiolex from non-cannabinoid drugs.

Invest in stocks with marijuana-related businesses

Some investors may prefer to reduce their risk (relatively speaking) by investing in stocks of companies that earn money otherwise, but who also have interests in marijuana-related businesses. The main disadvantage of this strategy is that returns may be lower than those of pure marijuana shares if companies other than marijuana do not grow as much as marijuana-related businesses. Constellation Brands and Scotts Miracle-Gro are two examples of shares in other sectors with marijuana-related activities.

Constellation Brands: This big liquor company is perhaps best known for its Corona beer. The company had sales of nearly $ 7.6 billion in its last fiscal year and posted profits of more than $ 2.3 billion during the period.

As mentioned earlier, Constellation's relationship with the cannabis industry was achieved through its investment in Canopy Growth. Constellation will own 38% of Canopy, assuming all mandates are exercised. Both companies plan to develop cannabis-infused beverages, which could be a great new market in Canada when regulations are finalized next year.

For investors, one of the main advantages of buying Constellation Brands securities is that they present a lower risk than value-added marijuana securities, such as Canopy Growth, because of its basic activity in the beverage sector.

Scotts Miracle-Gro: This company has made several acquisitions in recent years, including the purchase of Sunlight Supply in April, to become the leading supplier of hydroponic products in the cannabis industry. The company's CEO, Scott Hagedorn, recently said that Scotts "distanced itself from its competitors and clearly established Hawthorne as the market leader" in the cannabis industry.

A slow start to the recreational marijuana market in California has hurt Scotts' stock in 2018 so far. However, the state market seems to be gaining ground now. Scotts should also benefit, as more and more states legalize medical or recreational marijuana.

More than 92% of Scotts Miracle-Gro's total revenue comes from sales of lawn and garden products. This gives society a steady source of revenue while expecting continued growth with its cannabis-focused activities.

Invest in Exchange Traded Funds (ETFs) Marijuana

There are not many alternatives to exchange traded funds currently available that allow investors to buy a basket of marijuana shares. You might think that buying an ETF would reduce your level of risk. This may be the case, but it is also possible that there are only a few winners and that the losing stocks may lead to lower yields despite the excellent performance of the winners. The two ETFs currently available are Horizons Marijuana Life Sciences ETF and ETFMG Alternative Harvest ETF.

the Horizons Marijuana Life Sciences ETF attempts to replicate the returns of the North American Medical Marijuana Index. Canopy Growth, GW Pharmaceuticals, Scotts Miracle-Gro and many of the largest marijuana stocks in Canada are its largest holdings. With ETFs, expense ratios are essential. Management fees of 0.75% are relatively high compared to most index ETFs.

the ETFMG Alternative Harvest ETF is not a pure marijuana ETF. Its holdings include several stocks of tobacco and stocks of several biotechnologies that have programs on cannabinoids, but do not focus primarily on the development of cannabinoid-based drugs. However, the ETF's main holdings are Canadian marijuana growers, including Canopy Growth and GW Pharmaceuticals. ETMFG's net expense ratio of 0.79% is also relatively high compared to other index ETFs.

Invest or not invest?

Fortunes could be made on marijuana stocks over the next few years. However, it is highly likely that marijuana stocks will lose their fortune. Your decision to invest in these stocks or stay away depends on your level of acceptance of the risks associated with the high growth, high volatility marijuana industry.