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Things to Consider If You’re Thinking About Buying a Weed Stock

Cannabis stocks have been on a tear the last few years in Canada, but there are still many questions around how—or if you should even bother—trying to get in on the action.

by Anne Gaviola
Oct 16 2018, 6:45pm

Photo via The Canadian Press/Tijana Martin

This article originally appeared on Free CA.

Not all pot stocks are created equal. Some cannabis companies have been laying down a solid foundation on which to build a viable business in this high-growth industry. Others have made a lot of promises and freely used the words “cannabis” and “marijuana” in their marketing material without much to show for it. The legalization of recreational weed in Canada tomorrow is a kind of “TSN Turning Point”—with cannabis stock prices likely to come down shortly after this final step in the legalization process and many of the weaker players struggling to stay in the game over the coming months.

Of the 135 publicly-traded weed companies in Canada, “we’re going to see the winners and the losers differentiate themselves,” says Greg Taylor who manages the Purpose Marijuana Opportunities Fund. “No one has actually had to prove that they can execute, create great brands or win and we’ll know more about that in the next three-to-six months where everything goes from being a concept on paper to actual companies and a real industry.”

There are a lot of reasons why it makes sense to wait until after this week to get into the market. Right now, is a good time to start researching cannabis companies and figuring out if an investment in a weed stock in the coming weeks or months is a good fit for you.

Collectively, pot stocks have been on a tear over the least two-to-three years in Canada and experts say that, for some companies, this is just the tip of the iceberg. Taylor estimates the size of the Canadian medical cannabis market is about $2 billion and the recreational market is approximately $7 billion. That’s just the starting point. In North America, spending on cannabis is estimated to grow from $9.2 billion USD in 2017 to $47.3 billion USD in 2027.

Some call this the investment opportunity of a lifetime. “It’s really exciting that this is a brand-new industry that’s coming on and it has the potential to be positioned and led by Canadians,” says Taylor. “I think it’s something everyone should be looking at for growth in their portfolios.... We’ve already seen a lot of people get rich by investing in it.”

The FOMO surrounding this sector and the “gold rush mania mentality” are exactly what worries Brian Madden, who is a Senior Vice-President and Portfolio Manager at Goodreid Investment Counsel. He says the risk of “total, irreversible loss” is something potential investors need to consider. “Much like the early days of the internet in the mid-to-late 1990s when poorly-conceived new ventures abounded for a brief moment in time, only to fail a few years later.”

Investors in cannabis stocks should go into this with their eyes wide open about the potential to make and lose money. For the sake of disclosure, my husband and I invested a small amount of money in a highly speculative Canadian pot stock in the Spring of 2017 and a small amount in another cannabis penny stock earlier this year. We did our research and we invested money we were prepared to kiss goodbye (nothing that was supposed to go towards basic living expenses, rent, mortgage or to pay off debt). We don’t check our holdings daily and we have a long-term strategy.

The process of buying a weed stock is like purchasing shares in any other kind of company. You can do it through your bank or broker, or online through a discount brokerage (you can also call or visit a branch in person). The amount you need to get started depends on which platform you choose, and some have no minimum requirements (although you may be charged extra fees if you’re not using it regularly or only keeping a few hundred or thousand dollars in the trading account).

Regardless of how you go about investing, there are a few things to consider:

Size matters

If you’re looking for outsized gains, putting your money into one of the well-established cannabis names is probably not a good fit. The well-known leaders that have emerged are more expensive to buy and although that may help you sleep better at night knowing they’re not going to disappear overnight, you aren’t likely to reap huge financial rewards either.

The potential for a bigger reward with lesser-known names should be balanced with the knowledge that they may present a much greater risk than companies that have proven their viability.

Location, location, location

Although the consensus is that supply won’t be able to meet demand from recreational users across Canada immediately after October 17, experts and industry CEOs alike see a time, perhaps a couple of years from now, when supply will exceed domestic demand. Companies that have the ability to export outside of Canada will be at a strategic advantage.

Europe and its 739 million people and more than $1.5 trillion USD in healthcare spending has the ingredients to become the world’s single largest medical cannabis market. But when it comes to recreational spending, the US presents the biggest opportunity, and also the greatest uncertainty.

In America, 28 states have legalized medical weed and nine states plus the District of Columbia have legalized recreational cannabis. But pot remains illegal at the federal level, which means most cannabis companies there don’t have access to traditional banking services like lines of credit. Even though US President Trump said regulating cannabis should be left to the individual states during his election campaign, the White House seems to have flip-flopped on the issue. Reports in August suggest the Trump administration secretly launched an anti-weed committee. Experts say this is federal prohibition limbo is likely to linger until early next year.

Who’s running the show?

You should know what kind of management team is in place at any company you choose to invest in, and the cannabis industry is no exception. You want to look for a solid track record, and experience running a similar operation.

Genevieve Roch-Decter is the CEO of Toronto-based Grit Capital and she says the cannabis market’s three-year bull run has attracted some questionable people to the industry. “Everybody sees how much money you can make in this sector so you get a lot of these ex-investment bankers, ‘deal guys’ coming around with their pitch decks and they’ve never even grown a plant in their house. You have to stay away from guys that don’t have any experience because they’re just out there trying for a money grab.”

License or no license?

This one is easy and it applies to businesses with their eye on the domestic market. A company that is still waiting to get its licence from Health Canada is a riskier proposition. “There are over 200 companies waiting for license to be approved from Health Canada so I would just stay away from those types of situations,” says Roch-Decter. “18 months ago, if you didn’t have your license, that was a big catalyst. When you got it, your stock would pop. But (that’s not the case) anymore because now there are so many of them so it’s not as impactful a catalyst.”

The magic number

Like anything else you buy, deciding if it’s worth the price is key. Valuing a cannabis stock is tricky because often you’re looking at companies that haven’t yet reached their full potential. It’s coming, but we’re not there yet. You can find out what a company’s Magic Number, or valuation is, by doing simple math. This gives you a framework for comparing different names in the industry.

Take the company’s market cap (by multiplying its current share price by the total number of shares outstanding) and divide it by the revenue the company expects to make in two to three years. If that Magic Number falls somewhere between two and five, Roch-Decter says that’s a promising sign. She warns against putting money into weed names that have a really high number. “If it’s trading at 10-20 times, I would be very wary,” she says.

If all of this sounds as daunting as sorting through all the different weed strains that will soon be available, you have the option of hedging your bets with a basket of weed stocks, which are bundled together in an Exchange Traded Fund (ETF) or an index fund. These are investment vehicles that can be purchased like a stock but instead of getting exposure to a single company, you’re getting a bunch. Some ETFs are managed for you, meaning a portfolio manager keeps an eye on how the pot stocks are doing and executes an investment strategy for fees that are much lower than what you would pay with a typical mutual fund.

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