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Going Green: An investor’s guide to the marijuana industry

Going Green An investor’s guide to the marijuana industry

The war on marijuana is slowly coming to an end, and don’t investors know it. Very few industries have captured the imagination of Wall Street and Main Street quite like cannabis. With legalization sweeping the continent, many investors believe they are on the cusp of a generational opportunity that cuts across the medical, consumer goods and lifestyle industries.

The past 18 months have featured several watershed moments for the cannabis industry. The most profound moment came on election day, when seven U.S. states legalized recreational marijuana. North of the border, the Canadian government recently announced it will fully legalize recreational weed on July 1, 2018, some 17 years after it sanctioned medical marijuana.

These seismic shifts in public policy have left marijuana stocks seeing green, leading to an outpour of support in the mainstream investment community. But before investors get high off marijuana stocks, it’s critical to get educated about the industry. This will help separate fact from fiction in a sector brimming with more confidence than its fundamentals say it should support at the moment.

Legalization: Where We Stand

Seven states legalized marijuana in some form during the November 8 election. California, Maine, Massachusetts and Nevada voted in favor of recreational weed, while Arkansas, Florida and North Dakota backed legalizing medical marijuana.

From an investment perspective, much of the excitement emanates from the four states that legalized recreational cannabis. California is widely regarded as the proxy for the marijuana industry. If cannabis can succeed here, it can succeed anywhere.

Colorado has also given investors a good indication of how cannabis reform can generate growth. The sale of recreational marijuana topped $1.6 billion in 2016. That translates into $200 million in tax revenue for the state.[1]

Though legalization has been a resounding success in Colorado, the outcome is only a fraction of what California can achieve. For starters, California is eight times bigger, and if it were its own country, it would be the world’s sixth largest economy. California’s path from legalization to business generation will have a direct impact on the pot debate across the country.

The state has already vowed to fight a recent federal crackdown on recreational use, with an unusual alliance of government officials and the cannabis industry quickly taking shape. That’s because state lawmakers realize that marijuana is big business and a potential boon to the local economy. The November referendum also convinced state lawmakers that a huge swathe of the population was in full support of legalization.

Other States to Watch

Investors concerned about the federal ban on cannabis should take solace in the fact that the legalization debate is heating up across the country. In addition to the eight states that have fully legalized recreational cannabis, seven others are debating its future. The legalization debate is germinating in Delaware, Rhode Island, New Jersey, Vermont, Missouri, New Mexico, Kentucky and Texas, a sign they could be next headed to the polls.

Legalization was barely struck down in Arizona last November, with 51.3% of state residents voting against Proposition 205, a statute that would have permitted recreational use.

Canada

There’s just as much excitement about marijuana in Canada, which is expected to fully legalize recreational use of the plant in the not-too-distant future. In early April, the federal government filed an Act to Amend the Controlled Drugs and Substances Act with the legislation officially introduced two days later. Justin Trudeau’s government is expected to implement the legislation by July 2018.[2]

Although Canada became one of the first countries to legalize medicinal marijuana back in 2001, the nation’s marijuana industry is only worth about $100 million (keep in mind, Canada is one-tenth the size of the U.S. in terms of population and GDP).

Industry players are now awaiting provincial legislation on who will be allowed to sell recreational cannabis. To date, 40 marijuana licenses to grow the plan have been granted by Health Canada. Most of these companies are already sanctioned to sell marijuana to patients via mail-order system.

Marijuana Industry Growth and Future Potential

Perhaps no other industry has languished from pent-up demand more than marijuana. In the United States, the plant has been outlawed at the federal level since 1937. That’s 80 years of pent-up demand being met by the black market. During this period, there were few investment opportunities up until the recent growth of medical marijuana companies.

In just one year, marijuana has gone from an obscure and esoteric industry to a multi-billion-dollar enterprise that has resulted in the very first exchange-traded fund (ETF) being issued. The Horizons Medical Marijuana Life Sciences ETF (HMMJ) began trading on the Toronto Stock Exchange in April, ushering a new era for marijuana investments.

According to Arcview Market Research, revenues from legal marijuana sales reached $6.7 billion in 2016, an increase of 30% from 2015. Sales should rise at a CAGR of 25% through 2021 to reach $20.2 billion.[3] All this, and only around half of U.S. states have legalized marijuana to some degree. Analysts say that only broadband internet and cable television had a bigger growth trajectory than cannabis.

In Canada, legalized recreational weed could ignite a nearly $9 billion industry, eclipsing the combined sale of beer, wine and spirits, according to Deloitte. An estimated 600,000 kilograms (more than 1.3 million pounds) of weed will need to be produced to meet the expected demand. That’s far more than the country’s existing licensed producers are capable of growing for medicinal uses.

Clearly, there’s plenty of reason to be bullish on marijuana. The industry is already drawing parallels to the dot-com era, which provided value investors with a rare opportunity to generate enormous wealth in an extremely short period.

How to Invest in Marijuana

In terms of growth, very few industries can compare to cannabis. Like other industries, the leading marijuana companies can be bought and sold as stocks on the open market. In North America, these stocks can be found on the Nasdaq, Toronto Stock Exchange, TSX Venture Exchange and U.S. Over-the-Counter (OTC) market. Marijuana stocks traded Over-The-Counter contain the following symbol: OTCMKTS.

OTC is a decentralized market where investors can trade with one another through email, telephone and other electronic means. In an OTC environment, the dealer acts as the market maker by quoting prices at which they are willing to buy or sell a particular stock. An OTC trade can be carried out without others being aware of the price at which the transaction was made.[4]

Investors who wish to access OTC securities must open an account with a broker that allows Over-The-Counter trading. Since OTC securities are unlisted, there is no central exchange governing the market. This essentially means that all OTC trades must be placed through market makers, a type of broker-dealer firm that competes for customer orders. Typically, OTC securities can be traded on either a discount brokerage or full-service brokerage, including online trading accounts.

Just about any type of pharmaceutical or marijuana stock can trade on the OTC market. OTC provides access to companies ranging from large-cap conglomerates to small and micro-cap growth companies. Since most marijuana stocks are still in the early-stage or developmental phase, they typically do not qualify for the OTCQX Venture Market, which is the home of OTC stocks that are generally considered to be higher quality investments.

Companies listed in the OTCQB exchange are current in their reporting to a major regulator and have greater information availability to investors. Companies that are listed under the Venture Exchange have a green checkmark on the official OTC website indicating their information is verified. “Verified” securities are those whose profile has been confirmed by a representative of the OTCQB within the last six months. A growing number of marijuana companies have already made their way to the OTCQB.

It should also be noted that although investing in OTC stocks is more accessible than ever before, this avenue is considered riskier than conventional exchanges. That’s because many of the companies on the unlisted exchanges are very small, making them prone to wild fluctuations and added volatility. These characteristics define most marijuana stocks regardless of the exchange in which they are listed.

Investors trading marijuana stocks Over-The-Counter or through a conventional exchange should generally avoid companies with very little information. These companies may be extremely illiquid, thereby adding unnecessary risk to your portfolio.[5]

The Marijuana Index

The Marijuana Index is one of the easiest ways for investors to keep track of North America’s most prominent cannabis companies. The index and its subcomponents track the leading stocks operating in the legal cannabis industry in the United States and Canada. Naturally, the index is divided into two country sub-indexes: the U.S. Marijuana Index and the Canadian Marijuana Index. Each company tracked is assigned to either index, depending on the location of their primary business operations.

All three indexes began trading January 2, 2015, and were given an inception value of 100.00 points. The Marijuana Index is equal-weighted, which means each stock is granted the same importance as others in the basket. This is also the case for the U.S. and Canadian sub-indexes. The indexes are rebalanced on a quarterly basis on the last day of March, June, September and December.

As of Oct. 25, 2017, there were 311 companies listed in the Marijuana Stock Universe.

An Introduction to Marijuana Industries

The marijuana industry is more diverse than it appears at the surface. Although weed growers continue to receive most of the headlines, the industry features a large cross-section of businesses that span nearly a dozen sectors. In the following, we introduce investors to 11 industries operating within the broader marijuana sector (source: The Marijuana Index).

Agricultural Technology: The Agricultural Technology industry includes companies that contribute to the production and cultivation of marijuana by providing technologies, equipment and supplies to grower operations. Companies: Scotts Miracle-Gro Company (SMG), Zerez Holdings (ZRZH), Solis Tek Inc. (SLTK)

Pharmaceutical/Biotechnology: The Pharmaceutical/Biotechnology industry accounts for businesses focused on the research and development of pharmaceutical drugs and products involving cannabinoids. This industry represents the largest share of the U.S. marijuana market. Companies: GW Pharmaceuticals Plc (GHPH), Insys Therapeutics Inc. (INSY), Axim Biotechnologies Inc. (AXIM).

Consumption Devices: The Consumption Devices industry includes companies involved in developing and selling personal consumption devices, such as inhalers, for consumers of cannabis. Companies: Namaste Technologies Inc. (N:CNX), Wildflower Marijuana Inc. (SUN:CNX), Wildflower Marijuana Inc. (WLDFF).

Cultivation and Retail: Cultivation and Retail includes companies that grow and sell marijuana plants and related products. In Canada, this industry is dominated by licensed producers. Companies: Canopy Growth Corporation (WEED:CA), Aurora Cannabis Inc. (ACB:CA), Cronos Group Inc. (APHQF).

Hemp Products: The Hemp Products industry is primarily concerned with the production and sale of hemp and related products. Hemp is a member of the same plant species as cannabis, but has a lower concentration of THG and a higher concentration of non-psychoactive compounds. This makes it suitable for various products, such as paper, textiles and clothing. Companies: Medical Marijuana Inc. (MJNA), Earth Sciences Tech Inc. (ETST), Lexaria Bioscience Corp (LXX:CNX).

Investing and Finance: Companies involved in the investment and finance of cannabis, such as holding companies and asset managers, are also part of the dynamic marijuana sector. Companies: CannaRoyalty Corp (CRZ:CNX), First Harvest Corp (HVST), Amfil Technologies Inc. (AMFE).

Marijuana Products: The Marijuana Products industry is comprised of companies that are involved in the development and sale of marijuana-infused products, such as drinks, oils and lotions. Companies: Cannabis Sativa Inc. (CBDS), Radient Technologies Inc. (RTI:CA), Lifestyle Delivery Systems Inc. (LDS:CNX).

Other Ancillary: This industry consists of companies that contribute to the broader cannabis industry and that do not fit any of the other categories. Examples include companies that produce breathalyzers and testing kits, cannabis clinics and marijuana vending machine developers. Companies: Canada House Wellness Group Inc. (CHV:CNX), Cannabix Technologies Inc. (BLO:CNX), Lifeloc Technologies Inc. (LCTC).

Real Estate: Companies that develop, own or lease commercial property for the purpose of cannabis business are part of the marijuana Real Estate industry. If you want to own your property for your marijuana business then be sure to learn how to easily value a commercial property. This way, you won’t be paying too much for whatever building you want to buy. Companies: Praetorian Property Inc. (PRRE), Innovative Industrial Properties Inc. (IIPR), Grow Condos Inc. (GRWC).

Secondary Services: The Secondary Services industry consists of businesses that provide general consulting and business services to marijuana growers and retailers. Consulting services include market research, business development, branding and logistics. Companies: Cannagrow Holdings Inc. (CGRW), Novus Acquisition and Development Corp (NDEV), Americann Inc. (ACAN).

Technology and Media: The Technology and Media industry includes companies that provide software and media solutions to cannabis businesses and consumers. These services include enterprise software, e-commerce services and trading platforms for cannabis companies. Companies: Helix TCS Inc. (HLIX), Eco Science Solutions Inc. (ESSI), Bang Holdings Corp (BXNG).

Despite all the promise of recreational weed, most viable marijuana investments are concentrated in the medical biotechnology/pharmaceutical industry – at least for now. Investors looking for an immediate impact on their portfolio are more likely to succeed with a medical grower.

However, recreational weed is expected to be a huge money maker in the not-too-distant future. Favorable government policies, steadily growing public support and a burgeoning grower industry make recreational marijuana a promising enterprise across North America.

How to Build a Green Portfolio

Many of the same strategies involved in building a traditional stock portfolio also apply to the marijuana sector. Things like asset allocation, long-term strategy and deep fundamental analysis are critical for long-term success. At the same time, however, the marijuana industry has several unique features that investors need to grasp.

For starters, the marijuana industry is inundated with speculative investments and overhyped stocks that don’t actually have a viable business model. This isn’t always apparent when one looks at the relative success of marijuana stocks. This means many marijuana investments are overvalued.

Marijuana stocks are also highly volatile. After surging to record highs following legalization, many leading stocks found themselves in the doldrums in the first quarter as political uncertainty undermined confidence in the industry.

Against this backdrop, the following strategy is likely to yield the best outcome for investing in this rapidly growing sector.

1. Diversification is key

Diversification is the cornerstone of investing. For a sector like marijuana, where picking winners and losers isn’t easy, diversification carries even greater significance. Right now, there are over 250 stocks in the marijuana sector. Among them are future billion-dollar companies as well as duds that will eventually file for bankruptcy. A diversified portfolio of marijuana securities is therefore necessary to survive what could be a volatile few years for the sector.

2. Gain indirect exposure

There are both direct and indirect ways to gain exposure to a sector. Although most marijuana enthusiasts are rushing to growers and retailers, they should also consider other companies in the value chain that make the business possible in the first place. These companies are certainly benefiting from marijuana, but are not tied to it and thus won’t go bust if the sector hits a snag.

A company like Scotts Miracle-Gro (SMG) provides the type of indirect exposure our portfolio needs to survive volatile turns in the market cycle. SMG is not a marijuana stock, but provides specialty fertilizer and supplies to the pot industry. In other words, it is benefiting from the sector’s growth without being completely tied to it.

3. Conduct fundamental analysis

There are a lot of cool sounding marijuana stocks at play right now, but that shouldn’t be your criteria for investing. Nor should you rely on a hunch for picking a winner in a sector prone to wild price fluctuations. Remember: you are not picking from the S&P 500, but from a batch of companies that have an extremely limited track record in the market.

You should therefore come to terms with the stock’s intrinsic value (i.e., what it’s really worth). This means reviewing its business model, profitability, revenue, return on equity and overall growth strategy. In other words, read the stock’s financial statement carefully.

4. Don’t wait for a pullback to enter the market

Cannabis stocks may be volatile, but that doesn’t mean you should wait for a pullback before you invest. Although this is a common strategy investors employ, it rarely pays off. It may be painful to buy a share at 52-week highs, but it’s even worse to watch that company defy your expectations of a pullback.[6] The good news is marijuana investments are still new, so the good ones still have a long way to go before they reach their ceiling.

5. Develop a long-term plan

It’s perfectly acceptable to allocate a certain portion of your portfolio to speculation (i.e., choosing stocks you believe can be bought now and sold at a substantial gain later on). However, your overall portfolio strategy should be based on long-term objectives. This is the only true way to maximize investment success.

As a nascent industry, marijuana offers plenty of long-term growth. There’s lots of reasons to be bullish over its long-term prospects. This alone should deter investors from being too short-sighted with their cannabis portfolio strategy.

6. Know that you’re investing in an industry with top notch growth

The reason many people enter the cannabis market is the realization they may be investing in a once-in-a-lifetime opportunity. Legalization is long overdue, and pent-up demand is not like anything we’ve ever seen. This has been clearly reflected in the industry’s rapid acceleration in such a short period. The growth and widespread adoption of legal cannabis in all its forms should serve as a motivator for investors looking to tap into this sector.

Legalization and the Future of Marijuana Investments

Marijuana legalization across much of North America is a paradigm shift both in terms of public consciousness and public policy. Although the path forward will be riddled with uncertainty, the general trend is leaning toward looser regulation of recreational cannabis and increased support for medical research.

The marijuana sector is booming right now, but is trading at only a fraction of its full potential. The huge sales numbers we saw in 2016 are likely a sign of things to come, as the sector benefits from surging demand and growing mainstream acceptance of cannabis use. These factors could drive the next bull market in the marijuana industry – one that could rival the the dot-com boom.

From an investment perspective, cannabis stocks can still be had for relatively cheap. Like any breakout industry, there are a lot of duds out there trying to capitalize on the momentum. But there’s plenty of solid picks with fantastic growth prospects for investors with a little courage and a lot of patience.

credit:420intel.com

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