As institutional money flows into the legal cannabis industry, more retail-level investors might be wondering how to get in on the action. Here’s a primer.
Although the legal marijuana industry is still very much an emerging niche for stock market participants, the market for investing in cannabis is maturing.
In a recent sign of how far the legal cannabis sector has come, BlackRock Funds has made substantial investments in dispensary operator Curaleaf Holdings (CURLF), the same company that also announced it will sell products infused with a non-psychoactive hemp component in CVS Health (CVS) stores.
The CVS deal indicates that cannabis products are becoming more mainstream. The BlackRock investment is a high-profile example of institutional money entering a space that has been called the Wild West of investing. “We expect to see a floodgate [open] of more institutional investment,” said Matt Karnes, founder and managing partner with GreenWave Advisors.
More institutional money would help increase the liquidity of the sector—a good thing for investors who don’t want to get stuck holding an investment they may wish to sell. And if institutional money is now considering the space, it stands to reason that more retail-level investors might be wondering how to invest in cannabis, especially as the industry matures.
“We’re seeing more credibility in terms of management stepping into the industry,” Karnes explained, adding that executives have been migrating to the sector from the pharmaceutical and consumer packaged goods industries.
And with the push for legalization, marijuana companies are becoming more industrialized. Previously, the illegal industry was served by growing operations that weren’t very scalable, including those inside houses, according to Alan Brochstein, partner with New Cannabis Ventures and an analyst and portfolio manager with 420 Investor. Now, companies are using bigger facilities with heating, air conditioning, greenhouse, and larger-scale lighting technologies, he said.
Marijuana companies can be broadly divided into those that grow, process, sell, or distribute cannabis directly and those that service the industry, including with packaging and hydroponic supplies. There’s also the biotech segment of the industry, which aims to get products licensed through the government.
Although the classic image of marijuana use may be someone smoking a joint or eating a pot-infused brownie, as the cannabis industry matures, new ways of using both the psychoactive component THC as well as CBD (which won’t get you high) are blooming.
Consumer segmentation is occurring, as some companies are targeting certain users with products containing lower doses of THC than other products.
Another important division for those considering investing in the cannabis industry is Canadian versus American cannabis stocks. In Canada, pot is recreationally and medically legal at the federal level, whereas it remains a controlled substance federally in the United States even though a patchwork of states have legalized it in some capacity.
The regulatory risk is lower in Canada because pot companies don’t have to worry about the federal government seizing their assets and their executives going to jail, according to Brochstein. He added that although regulatory risk is higher for U.S. companies, they look better from a valuation and potential growth standpoint.
Investors wanting to get in early with a new cannabis company can consider investing in an initial public offering (IPO). When it comes to investing in IPOs, investors should be cautious. And with the special rules specific to this industry, cannabis IPOs could be considered even more risky investments than usual.
Plus, the cannabis IPO market—which often involves companies going public through reverse mergers—is very speculative, Karnes cautioned. “Not all of these reverse mergers have been successful out of the gate,” he said.
Plus, at this point, the cannabis IPO market seems to be getting flooded with new entries, making it less appealing.
Of course, investors can buy individual stocks, but that means doing homework on their markets, management, and finances. Another way to invest in cannabis stocks without buying company shares individually is to use exchange-traded funds (ETFs). Although ETFs can offer a way to distribute your investment across a range of companies, they won’t reduce the risks in the broader market, nor those inherent to the cannabis industry.
JJ Kinahan, chief market strategist at TD Ameritrade, noted that investing is difficult enough without adding the legislative burden that hangs over U.S. cannabis stocks.
For those who do want to take the plunge, cannabis companies should be a small part of their portfolio, and investors need to have a certain level of comfort holding risky investments for a long period of time, according to Kinahan. “Are you willing to sit with something knowing that there’s going to be a lot of emotional and perhaps legal upheaval?” he asked.
Brochstein advised investors should consider the management teams of marijuana companies. If you can’t find out much about the people running the company, that’s a red flag.
Another tip Brochstein has for potential investors in the marijuana space is to understand the capital raising cycle. When companies announce capital raises, their stock can get hammered, which he suggested could be a good time to buy depending on your investment style and risk tolerance.
Brochstein also recommended that investors should read a company’s actual filings, as press releases often contain a positive spin even on bad news.
“Do your homework,” Karnes said, quipping: “There are a lot of snakes in the grass.”
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