Should Investors Stop Buying Cannabis Stocks?

Marijuana stocks have been on quite a ride, peaking during the ‘green rush’ of 2018-2019, when broader legalization was on the horizon. Then

Oct. 17, 2020

Marijuana stocks have been on quite a ride, peaking during the ‘green rush’ of 2018-2019, when broader legalization was on the horizon. Then came the realization that black market competition and regulations in Canada were major obstacles to overcome. Soon after the crash came the promise of Cannabis 2.0, or pot derivatives like vape-oil, edibles, infused beverages, and topicals. But again, Canadian legislation was a hurdle and the sector suffered. 

All said, two ETFs that cover the sector, Horizon Marijuana Life Sciences Index and Alternative Harvest, are down over 70% from their 2018-2019 highs. Investors have a right to be concerned but the outlook is sunnier lately and we have some solid suggestions for long-term gains in the cannabis industry, along with a few caveats.

The bull case for cannabis stocks 

Weed dispensaries, deemed an essential business during the pandemic, have seen sales increase by nearly 40% year-over-year (YoY) and expected to exceed $15 billion by year’s end; further, sales are projected to rise to $37 billion by 2024. Recent polling reveals more voters supporting recreational legalization than ever before and should the Democrats win the presidential election, there is promise of decriminalization and legalization on a federal level. Growing unemployment rates and a need for more tax revenue are driving catalysts for legalization as well.

Aside from this, there is also the case of cannabis use as a substitute for opiates as states that have legalized marijuana on a medical or recreational basis have seen reductions in overdose deaths by as much as 35%. Encouraging data indeed, suggesting that people will opt for marijuana to treat pain rather than a hard-to-attain prescription to a drug that has a significantly higher addiction potential and ghastly side-effects. 

The industry is currently in a correction and much like the airlines, the companies that have concentrated on growth and have good financials will survive as the lesser organizations are weeded out. Companies like Aphria or Trulieve Cannabis Corp, up 25% and 90%, respectively, year-to-date (YTD), while the likes of Canopy Growth and Cronos Group have cushy cash positions thanks to partnerships with Constellation Brands and Altria Group, respectively, to weather any challenges.

The bear case for cannabis stocks

Almost none of the marijuana companies are profitable as black market competition remains a hurdle. Another pain point is high taxes in the U.S. that are factored into sales prices which are raised as a result. And what if the Democrats lose? That will mean no federal legalization and, as a consequence, fewer financing options for marijuana companies. This has driven companies like Aurora Cannabis (NYSE: ACB) to sell stock to raise funds, thereby diluting share value and losing stock price. 

Fraud and scandal can also besmirch the industry and limited legalization can provide that type of environment as was the case with CannTrust Holdings, which was found to be non-compliant in a grow operation by Health Canada. Another troubling development came from Namaste Technologies, whose former-CEO, Sean Dollinger, was terminated for committing securities fraud involving a shady sale of the company’s U.S. unit.

The outliers

Perhaps the safest investments in the cannabis industry can be found in outlier and ancillary industries like real estate investment trust (REIT) Innovative Industrial Properties, which specializes in leasing growing facilities to U.S.-based companies; so even if the company isn’t making money, they still have to pay rent and investors in the REIT benefit. The REIT’s stock price is up over 90% YTD and it pays a quarterly dividend of $1.17, a 3.57% yield. Another solid investment is Scott’s Miracle-Gro, a lawn-care company also specializing in hydroponic supplies which growers need; the company’s stock price has grown over 32% since the start of the year. 

No doubt the cannabis industry is in its infancy and may make investors nervous due to its volatility but if you prefer to hold off on pure marijuana stocks or to bolster your cannabis portfolio, you really cannot go wrong with the ancillary stocks until the industry recovers in earnest, becomes profitable and grows.

MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.