If there is an opportunity for growth in a new or hot industry, investors will likely flock to it. The cannabis business is no exception. But while this is technically feasible, it doesn’t mean that it’s likely or that it’s easy to do.
The cannabis industry has been on a wild ride over the last few years. Although stock prices fluctuated wildly a few years ago, they’ve majorly declined over the past year.
This is not entirely surprising. Any investment that provides an opportunity for significant growth must present a corresponding risk. This is true of all investments, not just those within the cannabis industry.
And in cannabis’ case, a number of investors had extremely high expectations that were bound to be disappointed. In addition to the risk of being a new and volatile industry, there are also risks that are specific to the marijuana industry, such as legality and regulation.
If you’re interested in investing in cannabis stocks, you’ll likely want to have a full understanding of the risks involved. For those who have a taste for investing in cannabis, here’s a primer to help you get started.
Investing in Cannabis
Before diving right into the question of how to invest in cannabis stocks, it helps to understand the general landscape of the cannabis industry. The regulation of the industry makes it unique.
Marijuana is big business, and although it’s grown as new markets open up, that growth hasn’t been reflected in the recent marketplace. According to a report by BDS Analytics , “legal cannabis sales at dispensaries across Arizona, California, Colorado, Oregon, and Nevada reached a combined $582.9 million, a nine percent decrease the trailing month and a 15 percent increase from the prior September.”
There are various potential reasons for this: a standard decline in sales in September, as well as recent studies on the harmful effects of vaping, which may have warned away buyers and customers.
And there are the legal hurdles to consider.
Currently, over 30 states , as well as Puerto Rico, Guam, Washington D.C., and the U.S. Virgin Islands allow doctors to prescribe cannabis for medical use, and 14 states and territories have legalized marijuana for recreational use in some form.
In January 2018, California legalized recreational marijuana use and is the largest state to have done so. It’s not hard to imagine a future where more markets open up, providing opportunity for businesses and investors alike.
But even as more states and territories legalize marijuana, cannabis remains illegal on the federal level. This creates a source of risk for the industry in the U.S. as a whole. The illegality of marijuana also creates a major roadblock for U.S. cannabis companies who want to access funding from banks or list their stock for sale on one of the exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ.
Still, some U.S.-based marijuana stocks are listed on one of the major U.S. exchanges. Others are listed on the Canadian Securities Exchange, which allows the listing of foreign companies. Some are listed on both.
Companies unable or unwilling to comply with regulatory requirements of listing on one of the major exchanges may list and trade in the lesser-regulated over-the-counter (OTC) market . This does, however, open the door for fraud to sneak in.
Canada, on the other hand, federally legalized marijuana in 2018 for both medical and recreational use. Therefore, many of the largest and most popular cannabis stocks are Canadian cannabis companies and traded on one of the Canadian stock exchanges, such as the Toronto Stock Exchange.
Investors in the U.S. are able to trade Canadian stocks via American Depository Receipts (ADRs) or the OTC market; here’s how .
Investing in Cannabis Stocks
There are two primary ways to invest in marijuana businesses through your portfolio. The first is by owning the individual stocks of cannabis-related companies and the second is through cannabis Exchange Traded Funds (ETFs).
Buying Individual Stocks
A stock represents a designated percentage of ownership in that company. When an investor buys a single stock—any stock—they have effectively purchased a small piece of that business. An investor purchases a stock in the hope that they get a slice of that company’s future earnings.
Investors can buy shares of companies that exist in the marijuana industry. Currently, many of the cannabis stocks exist within the medical marijuana space in Canada. Because medical marijuana has been legal in Canada for longer than recreational cannabis, it has dominated the investment space.
Now, investors can buy both U.S., Canadian, and some international marijuana stocks on major exchanges and others through the OTC market. No matter where an investor purchases a stock, it may be wise to proceed with caution.
While a listing on a major exchange does not imply that an investment is good or bad, stocks that aren’t listed on an exchange are often not held to as high of regulatory and reporting standards.
There are many different business types and models within the cannabis industry. When investors think of cannabis stocks, they may think of marijuana growers. But this is not the only type available for investors to consider.
For example, investors may be interested in biotech companies that are developing prescription drugs using the compounds found in marijuana (cannabinoids).
Also, there are companies that provide products and services to the cannabis industry itself, such as distribution, packaging, energy and lighting systems (for greenhouse growth), banking, and hydroponics. As the industry grows and evolves, the business of consulting will likely grow along with it.
Another way to look at investing in marijuana businesses is via companies that do the majority of their business in other markets, but that have growing cannabis-related arms.
An Exchange Traded Fund is a basket of investments, such as stocks or bonds. They are bundled together into a fund and traded on an exchange such as the NYSE or NASDAQ.
In general, ETFs are lauded for their ability to help investors access a broad array of investments at a low cost.
Most ETFs track some particular index (such as the S&P 500) in an effort to match that index’s performance over time.
An ETF could provide the investor a potentially simpler way to diversify their cannabis stocks holdings and to avoid the costs and research required of individual stock picking.
Currently, there are only a handful of ETFs to choose from. Within this limited space, there are both passive and managed marijuana ETFs. Managed marijuana ETFs may be a slight deviation from what many ETF investors are used to, as most ETFs (across all industries) utilize an index-tracking strategy.
Cannabis ETFs generally have higher expense ratios than those of the most popular, non-cannabis, low-cost ETFs. This is largely due to the fact that investing in individual marijuana stocks remains expensive, and the active management involved in curating stocks to hold in the ETF.
This may change as the marijuana industry grows and more cannabis ETF options become available to consumers.
Potential Risks of Cannabis Investing
It will likely not come as a surprise that there are significant risks to investing in cannabis stocks. Some of these risks are similar to the risks an investor would face in any hot, new, or volatile sector. Other risks are completely unique to the marijuana industry.
Either way, investors should know what they’re getting into. A good strategy to deploy when dealing with high-risk investments like cannabis stocks is to only invest what you can afford to lose.
Here’s a closer look at some of those risks:
Like mentioned earlier, in addition to the general market risk involved in investing in a new industry whose future of regulation is uncertain, fraud often attaches itself onto new, exciting, and unregulated or less-regulated industries and opportunities.
In a 2018 memorandum issued by the Securities and Exchange Commission (SEC), the agency warns investors that “scam artists often exploit ‘hot’ industries to trick investors, including by making false promises of high returns with low risks.”
The agency advises investors to research the background, registration, and licensing of anyone recommending or selling marijuana-related investments—unregistered persons are most likely to commit securities fraud. Further, beware of anyone who makes claims that an investment is high-reward and low-risk or no-risk, or makes unsolicited offers via phone, email, social media, or in-person.
Because marijuana is still illegal on the federal level in the United States, there is a legal risk to investing in marijuana-related companies. Companies with operations relating to the cannabis industry in the U.S.—whether or not they are listed on one of the U.S. exchanges—run the risk of breaking the law and facing criminal prosecution. Such prosecution could impact the value of your investment.
New Industry and Market
Because the legal marijuana industry is relatively young, so are many of the companies within it. Many of these companies have untested business models. While some of these businesses will surely find success, it’s hard to predict which without any sort of basis of what works well in this industry and what doesn’t.
From an investment standpoint, many of the stocks that are currently for sale in the over-the-counter market qualify as microcap stocks and penny stocks. Many of these companies have yet to post positive earnings and bear no track record. Microcaps typically experience a high rate of failure and are often highly volatile.
Marijuana stocks are more volatile than the overall market. This may cause even the most steadfast investor to become squeamish. (For instance, there’s the above mentioned downturn in the cannabis market over the past year.) Investors who aren’t comfortable seeing wild swings in prices may want to forgo investing in cannabis stocks.
The Bigger Picture
While some investors may find excitement in the hunt for the next big marijuana investment, it’s a good idea to not lose sight of the bigger picture when it comes to investing. Do marijuana stocks make an appropriate investment given your goals, risk tolerance, and investing time horizon?
The concept and practice of investment diversification applies to marijuana stocks and the marijuana industry.
Investors that decide to dabble in marijuana stocks may want to consider limiting their commitment to a small piece of their overall investment portfolio.
This way, the investor doesn’t run the risk of losing it all on one big bet on an industry that has already proven to be volatile.
For the rest of your investment portfolio, you may want to consider investing in a mix of stocks, bonds, and other asset classes using either ETFs or the individual investments themselves. Investors can do this through a traditional brokerage firm or with a financial services company like SoFi Invest®.
This service may suit investors who are interested in studying the markets and investments and building their own portfolios. Best of all, there are no fees for trading transactions, and investors can get started with any dollar amount.
And with SoFi Stock Bits you can invest in your favorite companies and ETFs without committing to a whole share. You can buy fractional shares and select stocks and ETFs starting at just $1. .
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