How to Invest in the Cannabis Industry

September 29, 2016 at 6:18 pm

With voters weighing in on an unprecedented number of cannabis legalization ballot initiatives in just 40 days, media attention is starting to ramp up. This year, Arizona, California, Maine, Massachusetts and Nevada voters will be deciding whether to tax and regulate cannabis for adult use, while voters in other states will consider establishing or expanding medical cannabis programs. While it is still quite early, many of the polls are predicting victories in the five states looking to legalize for adult use.

As I shared recently, cannabis stocks are heating up. Through September 28th, the Cannabis Stock Index was up 26.4% month-to-date. It’s quite evident that new investors (or traders) are entering the market, looking to capitalize on the macro trend of state-by-state adoption of cannabis legalization, and I have seen several former subscribers to 420 Investor return, seeking to better understand the fundamental and technical factors for the sector and the stocks within it. I have also observed a massive wave of promotion that is likely to intensify. Not only are publicly-traded cannabis-related companies issuing press releases at an accelerated cadence, but also newsletters are hawking their services with promises of “once-in-a-lifetime” opportunities to cash in.

Can investors make money by backing companies in the cannabis industry? While the answer is yes, it’s important to understand that one can lose a lot as well. The set-up for this election season, at least in the public markets, which are easier to measure than the private markets, is very similar to late 2013, right before Colorado legalized. This was an entirely different set of circumstances that won’t repeat to the same magnitude but is likely to play out somewhat similarly in my opinion. For those that invested in the average cannabis stock two months before Colorado’s legal retail cannabis stores opened on January 1, 2014 and held through the peak in mid-March, the gains were extraordinary at +800%:

This huge move took place as traders flooded into the market looking to make a quick buck. There were fewer than two dozen stocks that they could buy at the time, so it was pretty crowded. The momentum fed on itself, but, when the market topped, it ended very poorly:

There is no doubt that there is an exciting new industry, but investing in it is not easy. There are very few intermediaries helping to connect investors and cannabis businesses, so the market is highly fragmented. There are also few trusted sources of information, so investors are often on their own trying to navigate a complex industry filled with startups. Finally, it’s important to remember that the industry is federally illegal, which adds risks to both the operators and the investors.

If one is going to invest in the cannabis industry, there are two options: Public companies or private ones. To invest in a private company, typically one has to be accredited, meaning having an income above $200K ($300K for a family) or assets above $1mm. Anyone can invest in a publicly-traded stock.