The Grass Isn’t Always Greener: The Risks of Marijuana Stocks

Marijuana stocks have been described as the ‘gold rush’ of the 21st century, but behind the opportunity lay considerable risks investors must weigh before entering this unproven industry.  

Marijuana stocks are riding a wave of euphoria at the moment following successful legalization campaigns in seven U.S. states. Medicinal weed is now legal in a total of 28 states, with eight states also permitting recreational use. In no time, America’s nascent pot industry has witnessed a surge of capital as investors look to make their portfolios greener.

While it’s easy to assume 2017 will be another stellar year for marijuana stocks, the industry faces significant risks ranging from regulatory uncertainty to growing competition. What’s more, several of these stocks don’t actually have a real business, and are instead getting high on investor exuberance. Like any other emerging industry, marijuana investments are caught between fact and fiction.

Overhyped Penny Stocks

The marijuana industry in general may be hot right now, but not every stock is performing well. Even companies with the biggest valuations, like Insys Therapeutics (INSY), are under pressure. The specialty drugmaker lost roughly two-thirds of its value last year after its breakthrough fentanyl spray ran into legal issues. Now, many investors believe one of the sector’s most promising companies could be a major flop.[1]

Despite its recent struggles, at least INSY is an actual business. That can’t be said for many other marijuana companies that are trading as penny stocks and don’t have a sound business model or revenue stream. Investors should be especially wary about penny stocks because they are subject to large fluctuations due to low liquidity. (Avoiding these stocks will take much of the leg work out of picking sound marijuana investments.)

The surge in penny stocks reflects the growing number of companies flooding the industry to capitalize on the hype. But even a fast-growing market like marijuana can only support so many players. So, unless a company is developing marijuana-based drugs that are reviewed by the U.S. Food and Drug Administration, its chances of becoming a solid investment are slim. As INSY demonstrated, even companies at the leading edge of marijuana research provide no guarantee of success.

Business as Usual in Washington

We also wrote about how the new administration in Washington is not keen on supporting the marijuana industry or even creating avenues for its legalization at the federal level. Recently appointed Attorney General Jeff Sessions has been vehemently opposed to the legalization of marijuana, a view shared by many in Washington. This makes any challenge to the DEA’s existing classification of marijuana a pipedream.

President Donald Trump has also failed to provide any clarity on the future of the marijuana industry, having previously indicated that pot would remain a state and not a federal issue. From a regulatory perspective, this likely means business as usual over the next four years. Without meaningful policy reform, the marijuana business will continue to struggle with a lack of banking services and extremely high interest rates thanks to a section of the IRS code that prohibits drug dealers from writing off costs associated with illicit substances.[2]

Public Support Far from Guaranteed

Although marijuana use is gaining mainstream acceptance, public support is far from guaranteed. Several studies from reputable peer-reviewed journals have questioned industry’s underlying assumption that weed has medicinal benefits. Although new research has shown a compelling link between marijuana use and respiratory symptoms, other studies found little evidence that marijuana use increases appetite in patients suffering from HIV/AIDS.[3] Opponents of marijuana will likely use these and other studies to drive a wedge in the legalization debate and erode public support for recreational cannabis use.

It should be noted that amid the uncertainty, companies like Scotts Miracle-Gro (SMG) have emerged as the darling of the pot industry.[4] SMG is not a marijuana stock, but provides specialty fertilizers, lighting and other supplies that are driving the pot industry. SMG has enjoyed a 40% gain over the past 12 months as support for legalization has gained momentum.

The strong performance of Scotts Miracle-Gro proves that marijuana investment can be a fruitful endeavor, but only if you can separate fact from fiction. While investment opportunities may look attractive, marijuana stocks tend to lean in the direction of overhyped at the moment.  

[1] Keith Sepights (January 1, 2017). “3 Myths About Marijuana Stocks.” The Motley Fool.

[2] Joel Warner (April 14, 2016). “Marijuana Could Soon Be Rescheduled As A Less Dangerous Drug By The DEA, So Why Aren’t Cannabis Proponents Excited?” IB Times.

[3] National Academies of Sciences, Engineering, and Medicine. 2017. The health effects of cannabis and cannabinoids: Current state of evidence and recommendations for research. Washington, DC: The National Academies Press.

[4] Jack Kaskey (October 12, 2016). “Scotts Miracle-Gro Surges as Market’s Darling for Legal Pot.” Bloomberg.

 

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