The great part of owning risky stocks is the chance at reaping high rewards. You could lose money, but if things go well, you might reap an impressive return on your investment. Just look at the 660% return investors made on Canopy Growth Corp. between 2016 and today.
That opportunity still exists in cannabis stocks. The marijuana industry is still developing, as are laws and regulations that impact businesses operating in the space.
As with any stock, there are risks with investing in cannabis. But some unique characteristics of the cannabis industry means those same risky stocks could yield some high rewards too.
If you've asked yourself, "Should I invest in cannabis?" keep reading.
We'll look at the risks and rewards of investing in cannabis stocks and more.
Is the Cannabis Industry Filled with Risky Stocks?
Cannabis is a growing industry that intrigues many investors. But there are risks you should consider before deciding to invest.
We see four categories of risk in investing in cannabis:
- Legal restrictions
- Valuation
- Dilution
- Commoditization
Let's discuss each.
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Legal Restrictions
Polls show that most Americans support legalizing marijuana, especially for medicinal purposes. And many state governments are reacting.
So far, 33 states have legalized medical marijuana. Another six states legalized the use of CBD-oil products. (CBD, a chemical compound found in cannabis, is used in treatments for everything from nausea to depression).
More so, recreational marijuana use is legal in 11 states and the District of Columbia.
More laws are coming, though. As of January 2020, state legislatures and Congress were considering 975 cannabis-related pieces of legislation.
That could mean more regulation or it could change the way cannabis businesses operate. That uncertainty creates a risk for cannabis investors, but it's also an opportunity. As cannabis is legalized, we expect there to be more regulation. It's a sign of a growing and maturing industry. That means you can invest now before the industry reaches a mature stage.
Another legal risk is that marijuana is still illegal at the federal level in the United States. A cannabis-based business could face prosecution from federal authorities.
Most legal and industry experts think the risk of such prosecution is low. Still, the risk remains as long as the federal government classifies marijuana as a Schedule I narcotic.
That classification may change, eventually. The U.S. House Judiciary Committee voted in November 2019 to remove marijuana from the list of Schedule I narcotics. But Congress has taken no further action since that vote.
Cannabis's classification may be part of the reason why the U.S. Food and Drug Administration (FDA) has been slow to approve marijuana-based medicines. So far, the FDA's only approved one drug, a CBD-based medication called Epidiolex.
But this is why cannabis stocks offer such high reward. By investing in the right cannabis stocks before cannabis is removed from its Schedule I classification, you could reap a huge reward as money pours into the industry.
When cannabis is no longer prohibited by the federal government, we could see a string of new drug trials, more states willing to legalize, and banks and institutional money flooding the sector.
Valuation
A genuine concern to cannabis investors is valuation. Stock prices for cannabis-based companies are volatile as many companies are new and have short track records. Investors are looking at future growth potential, but they don't have perfect information. That means sometimes there are wild swings in stock prices as more information comes out.
Because the industry is so new and rapidly changing, it's tough to know when a stock is at a good price to buy or is overpriced. Even an existing cannabis business's numbers can be unreliable, since the environment in which they previously operated changed based on new laws and regulations.
There are tools available to help you make the most sense of each marijuana stock's value, and by using the experts at Money Morning,you'll have your ear as close to the ground as possible. That means knowing which management teams are the best and which companies' products are growing market share. This can help you find the best cannabis stocks even as other struggle to value the industry.
There will continue to be valuation risks for marijuana investors until there is a greater understanding of the market size and better measurements for cannabis companies' worth.
Dilution
Dilution is another risk for cannabis investing because marijuana businesses have a unique investing challenge.
Given the legal uncertainty around cannabis, these companies have fewer ways to raise money than businesses in more established industries.
Many banks won't loan to marijuana companies, for example. And while venture capital funding in cannabis is increasing, some venture capitalists are still hesitant to enter the industry.
This environment forces cannabis companies to look elsewhere to fund their growth. Many do so by issuing more stock.
That could reduce the value of the shares you currently own. And if you're a substantial investor, it could reduce your voting control in the company.
Like other risks in this field, the reward is generous.
Dilution can make cannabis a less-risky investment if companies become more profitable or investors and lenders become more comfortable working with the marijuana industry.
Not to mention, it gives you the opportunity to scoop up even more shares of top companies. That will pay off as the industry grows.
Until then, dilution remains a noteworthy risk for cannabis investors.
Commoditization
Cannabis is a crop, the same as oil, gold, wheat, corn, or soybeans. Like these other commodities, price is often the only differentiator between one supplier of the product or another.
That means as the market changes, cannabis crops can be worth more one year or less the next. If you invest in a marijuana grower, your profits could be affected by a good harvest or too little demand.
If cannabis producers grow more than the market can absorb, marijuana prices will drop. That can make it harder for some suppliers to make a profit, even if they have been well run businesses.
Of course, you can make money on commodities too. When demand is outstripping supply, the price will go up, meaning businesses will be making more money overnight.
However, one way to avoid this risk is to avoid investing in marijuana producers. The sector is still young, and there will be swings in supply. Stick with sectors of the cannabis industry less reliant on the commodity, like biotech and logistics.
Ways to Lower Your Risk
Even with these risks, investing in cannabis is enticing. It's a new and growing industry with huge potential.
If you've asked yourself, "Should I invest in cannabis?" here are some ways you can invest while reducing your risk.
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No. 1: Buy Lower-Risk Stocks
First, you can buy stocks in companies with less exposure to some of the risks mentioned above.
For example, Canadian cannabis businesses aren't as susceptible to U.S. legal concerns. Of course, depending on the company, it might be exposed to Canada's potential marijuana supply problem.
But the truth is you're unlikely to find a cannabis company not exposed to at least one of the risks listed above.
No. 2: Buy Shares in a Marijuana ETF
Another way to minimize your risk while investing in cannabis is to buy shares in a marijuana exchange-traded fund (ETF). These are investment funds comprised of stocks in cannabis-based businesses.
Buying into an ETF spreads your exposure across many companies. You're not putting your money into one or two businesses; you're investing in multiple companies. As a result, you lessen the negative impact on your portfolio if a single company performs poorly.
Here are some marijuana ETFs to consider:
- AdvisorShares Pure Cannabis ETF
- Amplify Seymour Cannabis ETF
- Cannabis ETF
- ETFMG Alternative Harvest ETF
- Global X Cannabis ETF
- Indxx MicroSectors Cannabis ETN
No. 3: Buy Stock in Companies That Support (but Don't Rely on) the Marijuana Industry
Another way to invest in cannabis while lowering your risk is to buy stock in companies that support but don't rely on the marijuana industry.
These can be businesses that provide products or services to cannabis companies. Or they can be businesses that include among their catalog some marijuana-related products.
One example is Scotts Miracle-Gro Co., which makes products used by many cannabis growers. Most of the company's customers, though, are outside the marijuana industry.
Likewise, another example is Molson Coors Beverage Co. It plans to launch six cannabis-infused drinks in Canada. It expects to release the first, a CBD-infused spring water called Flow Glow, in December 2020.
Investing in these companies could be a way to benefit from the cannabis industry's growth while reducing your portfolio's risk.
The Case for Cannabis Investing
Yes, there are risky stocks in the cannabis industry. But that's true any time you invest in stocks.
With cannabis, though, you have the chance to invest in a growing industry. That opportunity doesn't come along often.
And the cannabis industry's potential is a massive draw for many investors.
Buying stocks now in the right company can produce impressive returns down the road. The same can be true if you buy into a marijuana ETF.
With any investment, you should base your decision on research and your risk appetite. Are you comfortable putting money into risky stocks, knowing you might lose that money?
If you decide to invest in cannabis, look at the business plans and leadership teams for companies you're considering. Look to see which businesses you think are least exposed to the risks we covered above.
Some questions to ask when reviewing cannabis companies:
- Which do you think are best equipped to respond to legal and regulatory changes?
- Are there companies making enough money to fund themselves, thereby reducing your risk of dilution?
- Is there a business that likely won't be hurt by an oversupply of cannabis?
Ask these questions, and more, when investigating cannabis industry stocks. Doing so can reduce your risk and put your portfolio in a strong position to reap the rewards if marijuana takes off.
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