What to Look for When Choosing Cannabis Stocks

Marijuana stocks are an intriguing option for many investors. After all, cannabis stocks represent a growing industry with huge potential.

One estimate expects the global cannabis market to reach $40 billion by 2024. And marijuana legalization is increasing around the world.

A cannabis leaf imposed over a screen showing stock numbers and charts.

Recreational cannabis use is legal in four countries, including Canada, 11 U.S. states, and the District of Columbia. Some form of medical marijuana use is legal in 33 states and the territories of Puerto Rico and Guam.

One area that the marijuana industry is booming is in the use of CBD oil for medicinal purposes. CBD, or cannabidiol, is a non-psychoactive chemical compound that comes from marijuana. CBD is used to treat everything from nausea to depression.

The first U.S. Food and Drug Administration (FDA)-approved cannabis-based drug is a CBD oil product. Made by GW Pharmaceuticals, physicians use the medicine, Epidiolex, to treat seizures related to some forms of epilepsy.

Some industry insiders expect the FDA to approve more cannabis-based drugs soon, even those with THC, the psychoactive element found in cannabis. The FDA is currently studying the effects of cannabis and CBD oil.

With all this growth potential, many are clamoring to invest in cannabis stocks. But how can you pick the right marijuana stocks for your portfolio?

There are a few important things to look for when evaluating cannabis stocks. We'll show you how to find the best marijuana stocks and marijuana ETFs (exchange-traded funds).

Where to Buy Marijuana Stocks

Despite some of the legal regulations around marijuana in the United States, some companies have still successfully listed their stock on exchanges.

A few U.S. cannabis stocks are available on the New York Stock Exchange, including Aurora Cannabis Inc., Canopy Growth Corp., and cbdMD Inc. And others are on the Nasdaq, such as GW Pharmaceuticals and Tilray Inc.

In Canada, companies may have more ease with listing their stocks because marijuana is legal throughout the country.

That means you can find many Canadian cannabis stocks on popular exchanges, including the Toronto Stock Exchange. Examples again include dual listings like Aurora Cannabis and Canopy Growth, but also companies such as Aphria Inc. and CannTrust Holdings Inc.

You can also buy shares in cannabis stocks not listed on an exchange. You'll need to be, or work with, a broker to purchase these over-the-counter (OTC) stocks, and be aware of how to avoid potential risks.

OTC companies aren't required to disclose as much information about their business as those with stocks available on the major exchanges.

In addition to buying marijuana stocks, you can purchase marijuana ETFs. You'll find many cannabis ETFs on exchanges, including the New York Stock Exchange and Nasdaq.

Let's talk about how to evaluate cannabis stocks and marijuana ETF stock.

Company Leadership

One thing to look at is who is running a cannabis company.

A company's leadership team matters to the success of the business. That's especially true in the cannabis industry because of the regulations surrounding it.

Cannabis is a growing industry in an evolving field.

As of January 2020, U.S. state legislatures and the U.S. Congress were considering nearly 1,000 cannabis-related bills. That means laws and regulations are apt to change, perhaps frequently, across the United States.

A cannabis-based business with leaders who can adapt and respond to new laws and regulations is more likely to succeed in this environment.

When evaluating marijuana stocks, think about who oversees a company. Do any of those leaders have legal or regulatory backgrounds? How about experience in the cannabis or related industries?

For example, if you're evaluating a marijuana grower, does anyone on the leadership team have a horticulture background? If the company makes cannabis-based medical products, is there someone who has experience in pharmaceuticals or with the FDA?

You also want to review management's share ownership. How much stock do the company's executives own? Has a leader recently sold shares? Does leadership hold dilutive securities, such as stock options? If so, what are their exercise prices?

For example, a CEO selling a bunch of their company's stock could indicate the business is in trouble. If the management team owns large quantities of stock options, other investors could get diluted if those folks exercise their options.

Growth Strategy

Another aspect of investing in marijuana stocks is knowing a company's growth strategy.

If the company is based in Canada, does it plan to expand to the United States or other countries? Legally, it might take time before it can open U.S. operations. But not planning to do so could limit the company's growth.

If it's a U.S.-based company, how many states does it operate in? What is the plan to open in more locations?

A cannabis company that operates in numerous states can indicate some level of success, but it's important to make sure it is following regulations in each location. Each state has its own laws and regulations, meaning that the more locations a company does business in, the more time and money it could be investing to operate within the legal framework of that jurisdiction.

Another aspect of a company's expansion is its competitors.

How many competitors does a cannabis company have? Who are those competitors? Which business has the stronger brand?

Competition can make it tough for a company to grow. But competitors can also be a positive sign because their presence can indicate market demand and potential.

Product Offerings

Familiarizing yourself with the product offerings for the different cannabis businesses you're reviewing can help you determine if it's a worthwhile investment.

Is there a company with a product that's in high demand or well known? Does the business have a strong brand?

When investigating stocks in other industries, you often look at the companies selling name-brand products. Cannabis is no different.

Look at a company's products and see if they're leaders in the industry. Or, reverse-engineer by tracing a well-established product back to the business that provides it.

Branding plays a massive role in a company's success because it may be what separates a high-demand, prestigious product from its competition. Check out a cannabis company's product branding and the company itself to make sure you're not investing in a business selling a low-value good.

Another way to evaluate marijuana stocks is by seeing if a company has any partnerships. For example, the beverage industry is starting to partner with cannabis companies. These established partnerships could help bolster the success of a cannabis company and its future product offerings.

Constellation Brands, which makes Corona beer, owns 38% of Canopy Growth. Many expect Constellation and Canopy to produce cannabis-related beverage products down the road.

And Molson Coors is partnering with HEXO Corp. on cannabis-infused drinks. Molson Coors plans to launch its first CBD-infused spring water, named Flow Glow, in December 2020.

Financial Backing

How a cannabis company raises money is a crucial factor to consider.

It can be more challenging for marijuana businesses to raise capital than companies in more traditional industries. Many banks and venture capitalists invest in or loan to cannabis companies since cannabis is illegal at the U.S. federal level.

That means these businesses have to get creative in getting money to fund their growth.

One way some marijuana-based businesses raise money is by issuing stock. The more shares they release, the lower the stock price becomes.

That's good when you're buying marijuana stocks. But it could potentially hinder you if you already own shares in a company that issues more stock because the value of your shares drops.

When evaluating cannabis stocks, look at the company's financial reports. Some questions to ask include:

  • How much money does the company have in the bank?
  • Is it profitable?
  • What's its run rate? In other words, how much is it spending versus how much money it brings in?
  • How has it raised money so far?
  • When you reviewed its growth strategy, did the company disclose how it plans to fund its expansion?

Finding answers to these questions can help you pick a better-positioned marijuana stock.

Invest in Marijuana ETFs

Another way you can invest in cannabis stocks is to buy into a marijuana ETF.

An ETF, or exchange-traded fund, is an investment vehicle comprised of commodities, such as stocks and bonds. You buy shares in an ETF as you would a company. Your returns vary based on the collective performance of the commodities in which the ETF has invested.

There are many cannabis ETFs in which you can invest. Here are just a few:

  • Amplify Seymour Cannabis ETF
  • Cannabis ETF
  • Global X Cannabis ETF
  • Indxx MicroSectors Cannabis ETN

The most significant benefit of buying a marijuana ETF stock is that you're diversifying your risk. Instead of putting your money into one cannabis stock, you're spreading it out across multiple marijuana stocks.

Before investing in a cannabis ETF, make sure to assess potential risk factors.

As a growing industry with an evolving legal framework, cannabis stocks fluctuate wildly. This could present some level of volatility.

The U.S. Marijuana Index tracks cannabis stocks in the United States. Between January and May 2020, the index ranged from a low of $22.37 to a high of $134.41.

Expense ratios may be a downside to a marijuana ETF. Expense ratios are what ETF managers charge investors to manage the ETF. Cannabis ETFs tend to have higher expense ratios than other ETFs.

Even with these drawbacks, marijuana ETF stock can be a smart option if you're looking to invest in cannabis while minimizing your risk.

Picking the Right Cannabis Stocks

Even though investing in cannabis stocks is still new and evolving, the potential exists for impressive returns for those willing to invest in marijuana stocks. If that's you, following the guidance above can help you make a wise investment decision.

When considering buying a cannabis stock, review a company's:

  • Leadership
  • Growth strategy
  • Product offerings
  • Financial backing

If you decide cannabis stocks aren't for you, you can instead buy shares in a marijuana ETF.

Start at the beginning of our comprehensive guide if you'd like to learn more about marijuana investing. You can use the guide to discover many different types of cannabis businesses and discover the secret to choosing CBD stocks.

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