The cannabis industry is hotter than ever. Investments have already surpassed $3 billion this year, Viridian Capital Advisors estimates. And, according to New Frontier Data, sales are expected to surpass $9.5 billion in 2018.
In this context, marijuana-related companies are really reaching the mainstream, with two big ETFs, the Horizons Marijuana Life Sciences Index ETF (OTC: HMLSF) (TSE:HMMJ) and the ETFMG Alternative Harvest ETF (NYSE:MJ) trading on major stock exchanges, and businesses like weed grower Cronos Group Inc. (NASDAQ:CRON) and cannabinoid-based biotech GW Pharmaceuticals PLC- ADR (NASDAQ:GWPH) listing on the Nasdaq, and Canopy Growth Corp (NYSE:CGC) listing on the NYSE recently.
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While smaller companies have delivered astronomic returns (and losses) in the past few years, more established ones have been performing steadily. In fact, the United States Marijuana Index, which tracks 17 of the largest marijuana stocks in the U.S., posted gains of roughly 27 percent in the last three years, versus the S&P 500’s 28 percent. Still, it’s hard to hash out the good companies.
How can one tell the difference between a legit company and a good old pump-and-dump?
How to invest in Marijuana Stocks
At Benzinga, we strive to keep readers up to date with the latest news, stock picks, and expert commentary. But, as we continue to get the question about how you can invest in marijuana stocks, we’ve decided to put a brief guide together for you.
Before moving on, it’s important to note that investing in cannabis is not limited to growers or retailers. There are numerous companies providing ancillary services to the industry, as well as many derivative plays, like pharma and biotech companies making cannabinoid-based drugs and service/product providers that used to operate outside the marijuana industry but have gotten on board since legalization.
The over-the-counter issue
While multiple states in the U.S. have legalized cannabis for either recreational or medical uses, allowing companies to thrive, the plant is still illegal on a Federal level – classified as a Schedule I drug by the DEA. This has made it difficult for many companies to get listed on the Nasdaq or the NYSE.
Seeking alternative avenues to raise capital, some businesses have gone public by trading on over-the-counter exchanges. This means that many publicly traded cannabis companies are not subject to the same level of scrutiny that major exchanges and the SEC impose.
“The over-the-counter exchanges present challenges. They’re not taken as seriously as the bigger exchanges, and they also allow for a greater degree of latitude in terms of the quality of the company that will trade on them. As a result, many of the companies (…) that have something to do with cannabis probably shouldn’t be there. They got there because entrepreneurs thought it was the only way they could get access to capital; there was somebody that had a publicly traded vehicle that seemed like it would be a good fit,” Leslie Bocskor, investment banker and President of cannabis advisory firm Electrum Partners, told Benzinga.
Having said this, he added that not all OTC or penny stocks are to be avoided at all costs. “There is a prejudice against low priced stocks that I think we need to get away from as an industry and start looking towards reverse splitting our stocks, having fewer numbers of shares and higher prices because the optics on it are better,” Bocskor voiced.
It takes a greater effort to read and comprehend the SEC filings, but the effort is worth it, as these give a more complete perspective of the fundamentals. Also, if the company doesn't file with the SEC, you should probably not pay attention to it.
420 Investor Alan Brochstein seems to differ on this point though. “It’s extremely important not to rely solely upon company press releases, as these are typically positive spins,” he says. “It takes a greater effort to read and comprehend the SEC filings, but the effort is worth it, as these give a more complete perspective of the fundamentals. Also, if the company doesn’t file with the SEC, you should probably not pay attention to it.”
How to hash out the bad weed stocks
So, we’re still faced with the same question as we were a few paragraphs ago: how does one pick good cannabis stocks and avoid bad ones?
While it is always recommended that retail investors do their own due diligence, going over hundreds of filings and corporate documents can be hard and time-consuming. Moreover, most people usually don’t have access to the resources needed to make an informed assessment of a company.
But there are options. One of them is investing in ETFs like the ones mentioned above: Horizons Marijuana Life Sciences Index ETF and the ETFMG Alternative Harvest ETF. These instruments make it easy to invest in cannabis stocks that have already been pre-selected by teams of analysts who’ve conducted the necessary due diligence and decided to include certain companies in these ETFs.
Another option for those looking to build out their own portfolios is recurring to investment advisors and stock pickers like Alan Brochstein or Jeff Siegel of Green Chip Stocks.
“A lot of the Canadian cannabis stocks are quite overvalued right now,” Siegel warns. “I’m telling my readers to start focusing on some US cannabis stocks, as this is the next big market. Companies like MariMed (OTC: MRMD) and Innovative Industrial Properties (NYSE: IIPR) are doing quite well as the US cannabis market becomes more attractive.”
The six steps to retail investing
So, to make things simpler, here’s a list of six steps you should be taking when investing in cannabis stocks – or any other sort of security, for that matter.
Step 1: Research the company
Always start by researching the company or companies you’ll be investing in. Check SEC filings and other documents required by diverse regulatory agencies. Also, read the latest news on these companies in site likes Yahoo Finance and get a feel for the market sentiment using Twitter or Stocktwits.
Step 2: Determine the amount to invest
As a rule of thumb, never invest more than you can afford to lose. While good research will often lead to strong returns, this will not necessarily be the case. Stocks are volatile and contingencies sometimes unpredictable.
In relation to this point, Brochstein says, “I find many people place too much confidence in just one or two ideas. In a start-up industry, which is what legal cannabis is in many ways, it’s not easy to pick the winners. If you go back to the late 1990s, a lot of the companies that many expected to be winners didn’t even survive three years. My longer-term focused model portfolios typically have a dozen names in them.”
Step 3: Decide on your timeline
Deciding on when to buy and when to sell is crucial. Try and figure out what your thresholds are beforehand. So, for instance, establish a rule: “if the stock falls below X or surges above Y, I’ll sell.”
Step 4: Pick a broker
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Once you’ve gone through the initial steps, you’ll be ready to actually buy your shares. You can go old-school, with a brick and mortar broker like Scottrade or sign up for an online broker such as E*Trade or Interactive Brokers. Both options will allow you to buy and sell stocks once you’ve registered and funded your account.
Step 5: Buy the stock
This step may sound self-explanatory, but it’s a bit more complex than it seems.
“There are generally two types of ‘buy’ orders: market order and a limit order. A market order will execute the purchase at the present market price, while a limit order will only execute if the price falls at or below the limit price. Although a limit price might give an investor a lower price of entry, there is no guarantee that the limit order will execute,” Benzinga’s Thomas Rudy explains.
Step 6: Sell the stock
Once you feel you’ve generated enough returns from a stock, it’ll be time to sell. Again, you can sell the stock with a market order or a limit order. Use your proceeds to reinvest or just spend them. Life is meant for living!
Trading around a core
One of the processes that have helped Brochstein perform well in his model portfolios has been what he likes to call “trading around a core.”
“This strategy takes advantage of the inherent volatility in these stocks, The way it works is that you sell incrementally when the stocks are rallying or buy incrementally when the stocks are declining,” he explains.
“It’s important to make sure that the position deserves to be a holding, but if you are confident in the long-term prospects for the stock, varying your exposure can allow you to ‘buy the dip’ or ‘sell the rip’ and not get left on the sidelines or get buried if the stock moves higher after you trim your position or lower after you add to it. To be real clear, if you go ‘all in’ on a stock and make it 50% of your portfolio, what are you going to do if it drops further? If you sell out of what you think is a great long-term holding because it has reached a level you didn’t expect, will you then be willing to pay more to buy it back in the future if it never falls?”