Will Cannabis Stocks Go Up In Smoke?

These are exciting times for investors who enjoy first mover opportunities. With the budding new industry being created by the legalization of medical cannabis across North America and the world and, consumer cannabis in Canada, investors who are willing to tolerate high volatility have the opportunity of a lifetime. To get into a developing industry on the ground floor gives the investor an incredible opportunity, but not one without it fair share of volatility. With the number of public and private companies looking to capitalize on consumer demand for cannabis, navigating the terrain and picking winners is a daunting task.

There are several ways to play the cannabis industry including pure stock plays, peripherals, and partnerships. In this article, I want to focus on pure stock plays and then address peripherals and partnerships in future blogs. I do not want to focus on individual companies per se’ because, a simple google search will give you more information that the average person can digest. What I would like to discuss is the S.W.O.T. of investing in cannabis as a pure stock play.

The first caution of cannabis investing is to employ the following three strategic concepts:

§  know thyself

§  know the market

and

§  know the company

First, Know Thyself: Temperament can limit one’s ability to overcome the emotionality of volatility. If you are more prone to intellectual efficiencies, your ability to make decisions based on logical data will serve you well. However, if you are more apt to react emotionally to volatility, you will have to work extremely hard to invest in the cannabis market. It is often said that intellectuals can think themselves into anything and emotional people can feel themselves out of everything. If volatility causes you to freak out, then stay out of cannabis.

But volatility is one aspect of the market that can cause insecurity when trading in cannabis stocks. An investor must temper his or her greed as well. It is easy to convince one’s self that buying a large number of shares at a low price is a sound investment. After all, if the company excels, you make more money. However, the best advice I could offer is this.

If you, as an investor, decide that the cannabis industry has a place in your portfolio, then diversify across multiple companies. By having a small number of shares in many companies, you position yourself to capture arbitrage from M&As and well as partnerships which may form with more traditional companies such as tobacco, beverage and even confectionary companies.

Second, Know the Market: Since the cannabis industry is still developing, knowing the market is not as easy as it sounds. Knowing the market happens at the macro-level. It is big picture and following legislative decisions will help you navigate the industry. If the current U.S. administration bends its ear to the purveyors of cannabis, you can bet the early investors will benefit the most. Once institutional investors are given the green light, you can sit back and watch the money roll in and the stock prices go up.

In addition to the above, there is likely to be a lot of M&A action as companies vie for market share and one-ups-man-ship. Several companies have already participated in acquiring smaller niche companies. This happens in every industry, but will accelerate in the cannabis industry as the real players emerge. Knowing the M&A market as it pertains to cannabis will be highly important concerning the third caution of cannabis investing.

Third, Know the Company: Learning how a company wants to position itself within the industry will provide the investor key information as to the viability of the company in this space. Knowing the company happens at the micro-level. An investor at this level, needs to know the profiles of the companies, which are literally creating a new industry. This is key to determining what direction you want to go as an investor in cannabis. Here are a few of the top companies in this space and their profiles.

• Aphria is positioning itself as a low-cost pot producer
• Aurora Cannabis investments may be more valuable than its pot
• Meet Cronos, the Heinz Ketchup of weed
• Canopy Growth is the cannabis business’s $4 billion gorilla
• GW Pharma is a drugmaker that grows its own cannabis plants
• Vancouver Island–based Tilray has global ambitions

Information derived from Yahoo Finance.

Knowing that Aphria is looking to capture the low-cost market lets an investor understand the market, but it also gives valuable information about potential M&A activity and potential partnerships. With Aurora having investment more valuable that its cannabis products could make it an attractive acquisition target. Each profile gives an investor information about the direction of the company. Tilray, having global aspirations, puts them in the driver’s seat for acquisitions.

So, what might some of the Strengths, Weaknesses, Opportunities, and Threats faced by the investor concerning the cannabis industry be? One of the top strengths of the industry for investors is the newness and acceptance of cannabis. The world is quickly changing (whether for better or worse) and acceptance of cannabis by the general public is gaining momentum. However, this new acceptance is fraught with regulations. This weakness could make the growth of the market limited and susceptible to legal actions, as we have seen with tobacco.

In addition to that, there is the enticement of making large returns via capital gains. Opportunities to buy in at times of negative volatility (when stock prices fall violently) and selling during positive volatility (when stock prices rise rapidly) can result in decent gains in one’s portfolio. Timing is everything in this market and those with the best sense of timing will do well.

Finally, the greatest threat for the investor, I believe, is the government. Since the government thrives on taxing additive substances (consider tobacco and alcohol) there is no doubt they will use cannabis as another revenue source. In order to legally grow and distribute cannabis, a company must operate within the confines of the law, but this does not necessarily mean the black market will dry-up. Since it will be legal to possess and consume cannabis, once purchased, there is no way for the law enforcement community to know where someone purchased the product.

Illegal purchases will not only reduce the tax base, but it will also take money out of the pockets of the companies’ investors are looking to invest in. The industry has great early market mover opportunity, but will experience strong volatility until the dust settles and the leading players begin to solidify their position.

As a pure stock play, the investor should expect significant volatility along with some great opportunities until the market settles into its new reality. The best companies will rise to the top and the less significant companies will likely be acquired by the bigger players. Which company offers the best opportunity is based on the investor’s perception and own direction. Remember, know thyself, know the market, and know the companies. These three analytical concepts will help any investor make better decisions and improve his or her ability to navigate the cannabis industry.