What to Look Out For in Marijuana's Volatile Early Days

Written by Nick Hodge
Posted February 20, 2018 at 7:00PM

Marijuana stocks had a monster run late last year and early this year.

If you had bought the Horizons Marijuana Life Sciences ETF (TSX: HMMJ) below $10 before Halloween you would have doubled it by the New Year.

Marijuana ETF HMMJ 2Holding another 10 days would’ve earned you another 50% for a total of 250-some-percent on your money. Five percent per day isn’t bad work if you can get it.

Then, of course, the inevitable happened — the sector began to pull back.

First, the ETF — which represents, in essence, the sentiment of the entire sector — pulled back from new highs above $25 to $19.

It bounced off $19 in mid-January but couldn’t get to its highs again, which was the real stalling point for the rally.

And then, of course, the market suffered its worst two days point-wise in history, so that took it down to $15, from which it’s now recovering. Again, “it” here is the entire sector of marijuana stocks.

It’s not hard to see the sector is sort of leveling out now — looking for direction.

A few points on all this…

This is clearly a very volatile sector. You have to know that going in as an investor.

Valuations are running fast and loose.

One of the largest weed stocks, for example, Canopy Growth (TSX: WEED) — with its C$5.8 billion market cap — did just $21.7 million in sales in the most recent quarter. Call it a run rate of $100 million in annual revenue and that’s a hefty 58X revenue multiple.

What’s scary and exciting is that no one really knows what the true valuations should be. The stuff’s still not legal yet in most places!

This is still very much in the speculation phase. And so catalysts matter. Look at the chart above again.

We saw a steep run-up in November because pot was on several ballots, most importantly in California.

Then the next sharp spike came in late December and early January as legal cannabis was actually implemented in California.

We expect the next big bump to come this summer as Canada legalizes recreational pot nationwide. The details are still emerging on this, with the original date scheduled for July 1.

But government being what it is, the date is now fluid. It still expects to pass legislation in July, but sales will commence a bit later in the summer subject to individual provincial rules.

Either way, it’s coming. So as the CEO of Canopy was recently quoted saying, “…if it’s July 10 or 18, I don’t really care.”

Expect renewed interest (read: buying) as this date approaches.

And finally, there are still further catalysts ahead.

Merger and acquisition activity will continue to heat up as major liquor and tobacco brands fear having their lunch eaten. That will give us a better grasp on valuations. Indeed, Constellation Brands, importer of Corona, has come in to take a stake of Canopy.

And other major markets still need to open up, namely the United States, which is by far the largest. This will happen in time.

Until then, it’s important to weather the current volatility while preparing for the catalysts ahead.

One thing that’s important to note is that Canadian companies — like Canopy — are currently the biggest in the world. But they are not allowed to operate in the United States per stock exchange rules.

Changing legal frameworks are a hiccup of any fast-growing new industry. And as it stands, the owner of the Toronto Stock Exchange just said last week that cannabis companies listed on its exchanges are not allowed to operate in the U.S.

What that means is you can invest in stocks, like Canopy, that are early leaders in the global cannabis space. But you will not be getting any exposure to the U.S., which is expected to be the largest market.

So our cannabis editor, Jimmy Mengel, went on the search for a U.S.-listed company poised for rapid growth here at home.

And he’s found what he’s calling the “Apple of Weed” already with a foothold in the Californian market but poised for quick expansion.

It’s still very early days in the marijuana sector. There are many factors to consider, especially the world’s largest companies currently barred from operating in the United States.

Here’s a good shot at getting some of that crucial exposure.

Call it like you see it,

Nick Hodge Signature

Nick Hodge

follow basic@nickchodge on Twitter

Nick is the founder and president of the Outsider Club, and the investment director of the thousands-strong stock advisories, Early Advantage and Wall Street's Underground Profits. He also heads Nick’s Notebook, a private placement and alert service that has raised tens of millions of dollars of investment capital for resource, energy, cannabis, and medical technology companies. Co-author of two best-selling investment books, including Energy Investing for Dummies, his insights have been shared on news programs and in magazines and newspapers around the world. For more on Nick, take a look at his editor's page.

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