Cannabis Investing 101

The trend toward cannabis legalization has turned the business of growing it and selling it into one of the hottest industries in recent years.

The legal marijuana market is estimated to have reached $20.1 billion in 2020, and numerous cannabis-related companies are publicly traded on stock exchanges. Such trends have lured stock investors who are eager to benefit from potential gains. But wild swings in marijuana company shares show how volatile the industry can be.

And while some believe increasing acceptance of pot for medicinal and recreational use will continue to expand the space, the road to legalization, regulatory oversight and full-scale commercialization could be rocky.

Here’s a guide on how to get started in cannabis investing.

Overview of Cannabis Legalisation

Let’s start with the general landscape of the cannabis industry. Currently, 36 states in the U.S., as well as four territories, have legalized cannabis for medical use. In February 2021, Virginia became the 16th state to legalize marijuana for “adult use” or recreational purposes.

Such expansions have led to big growth predictions. The legal U.S. cannabis is forecast to hit $41.5 billion in 2025–more than three times a $13.2 billion size in 2019, according to cannabis research firm New Frontier Data . Meanwhile, the illicit market in the U.S. is expected to stagnate at $66.9 billion from 2020 through 2025, the report shows.

Cannabis remains illegal on the federal level in the U.S. However, shares of cannabis companies soared in late 2020 and early 2021 as election wins by Democrats bolstered the belief that national decriminalization of cannabis was on the horizon. Senate Democrats have, in fact, said they will try to pass legislation in 2021 that would end federal prohibition.

Recommended: The Election’s Impact on Cannabis Stocks

Outside the U.S., Mexico in 2021 legalized recreational marijuana, becoming the largest market for cannabis in the world. It followed Canada, which in 2018 made the same move. Investors in cannabis stocks can monitor how countries around the world are weighing marijuana legalisation.

How to Invest in Cannabis Stocks

The main ways investors can get exposure to marijuana businesses in their portfolios is by first, owning the individual stocks of cannabis-related companies. The other option is through cannabis-themed exchange-traded funds, or ETFs.

Cannabis Stocks

Historically, cannabis companies tended to be private. But in Canada, medical use of marijuana has been legal since 2001, making the Toronto Stock Exchange and TSX Venture Exchange the listing venues for many cannabis-related businesses. Investors in the U.S. are able to trade Canadian stocks via American Depository Receipts (ADRs).

Then in 2018, medical marijuana company Tilray became the first cannabis company to directly list in the U.S., having its initial public offering (IPO) on the Nasdaq Stock Exchange.

While a listing on a major exchange does not imply that an investment is good or bad, stocks that are listed on an exchange are held to higher regulatory and reporting standards. Those that don’t qualify to be listed on an exchange typically trade over-the-counter (OTC).

No matter where an investor purchases a stock–on an exchange or OTC–it’s wise to be cautious. Not all marijuana-related companies are profitable, as many are still heavily investing in their businesses.

Different Types of Cannabis Companies

When investors think of cannabis stocks, they may think of marijuana growers. But this is not the only type of business available for investors to consider.

•   Investors may be interested in biotech companies that are developing prescription drugs using the compounds found in marijuana (cannabinoids).
•   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–a plant-growing method that involves no soil.
•   Another way to look at investing in marijuana businesses is via companies that do the majority of their business in other markets, but have growing cannabis-related arms.

Marijuana ETFs

An ETF is a basket of securities, such as stocks or bonds, that’s packaged into a single share that investors can find listed on stock exchanges. Many ETFs mirror the moves of an underlying index, like the S&P 500 Index or Nasdaq 100 gauge.

In general, ETFs have been lauded for their ability to help investors get exposure to a broad array of investments at a low cost. Similarly, a cannabis ETF could potentially allow an investor to diversify their stocks holdings, while avoiding pricey management or transaction fees and the research required when picking individual stocks.

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 include in the ETF.

Cannabis ETFs may also hold fewer stocks than more traditional ETF. This is typical of so-called thematic ETFs, ones that allow investors to wager on more niche trends. While such funds allow for more targeted bets, investors are also exposed to fewer names, making it more likely that a big move in one company will impact the price of the ETF as a whole.

Recommended: The Pros & Cons of Thematic ETFs

Potential Risks of Cannabis Investing

Marijuana stocks have tended to be more volatile than the overall market. In addition, pot stocks have also been a target for short sellers–investors who bet shares of a company will fall.

Investors who aren’t comfortable with such stock volatility may want to forgo investing in cannabis stocks.

Legal & Regulatory Risks

Because marijuana is still prohibited on the federal level in the U.S., there can be a legal risk to investing in pot-related companies. For instance, cannabis-related businesses in the U.S. are prohibited from using banks for their transactions.

In addition, even if the U.S. were to pass federal legalization, that doesn’t mean growers and retailers will be able to sell their products immediately under a streamlined regulatory structure. Some states may put in place new regulation that makes pot sales and usage onerous.

After Canada legalized marijuana in 2018, many people thought that the move would lead to quick sales and profits. But in reality, the opening and licensing of cannabis stores took place slowly. Plus, illegal pot sales continued to thrive and compete with the legal marketplace.

In the first year after legalization, the stock value of Canada’s six largest marijuana companies plummeted by more than 50% on average.

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.

From a stock investment standpoint, many of the stocks that are currently for sale in the OTC 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.

Separately, unexpected developments and news reports may hit a new industry like cannabis. For instance in 2019, many pot stocks took a dive amid concerns that vaping was tied to a serious respiratory disease.

Fraud

In addition to the general market risk that comes with investing in a new industry, fraud often attaches itself to new, exciting, and less-regulated industries.

In a 2018 investor bulletin , the Securities and Exchange Commission (SEC) alerted investors that their office regularly receives complaints about marijuana-related investments. “Scam artists often exploit ‘hot’ industries to trick investors,” the regulator said.

The SEC said investors should particularly be wary of risks related to investment fraud and market manipulation. Investment fraud includes unlicensed, unregistered sellers; guaranteed returns; and unsolicited offers. Meanwhile, market manipulation can involve suspended trading in shares, changes to a company name or type of business, and false press releases.

Investing in Marijuana Cryptocurrencies

Because cannabis is still illegal in the U.S. on the federal level, pot-related businesses are barred from conducting transactions through banks.

Marijuana cryptocurrencies are virtual currencies that were designed to try to solve this problem for pot-based businesses. However, many of these marijuana cryptocurrencies haven’t really taken off in terms of usage or market price.

Recommended: Understanding the Different Types of Cryptocurrencies

The Takeaway

Hunting for the next big marijuana investment may seem like an exciting endeavor. But investors should keep in mind that the cannabis industry may continue to encounter obstacles even if legalization on a broader scale occurs in the near future. And outside the regulatory challenges, cannabis-related businesses tend to be newer, untested, and not yet profitable, posing greater risks for investors.

For investors who want a hands-on approach, SoFi Invest®’s Active Investing platform may be a good option. It allows investors to trade stocks and ETFs free of commission on their desktop or phone. If there’s a particular company an investor wants to buy, but it’s share price is too high, SoFi’s Stock Bits offering allows purchases of fractional shares–slices of a whole stock.

Get started with SoFi Invest today.

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