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The massive marijuana stock rally following the media frenzy when Colorado’s legal cannabis system kicked in earlier this year has all but fizzled. As measured by the Benzinga 420 Marijuana Index, the stocks, which had more than doubled from the August 2013 lows into year-end, increased an astounding 7X in the first 80 days of the year only to give up most of their gains:

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While the stocks are still up in 2014, most investors have lost money after entering the market after the rally began. With prices substantially below the peak levels from earlier this year, marijuana stocks might have some appeal.

5 Reasons for Caution

  • These are “penny stocks”: With the exception of GW Pharmaceuticals, a UK biotech company that trades on the NASDAQ, the cannabis stocks trade on the OTC. Investors are faced with poor disclosures, and the companies have limited access to capital.
  • SEC: The SEC has suspended trading in 11 marijuana-related stocks since March, and this has led to investors retreating from the market. Suspended stocks are sent to the “Grey Market” after a two weeks period without trading, and typically they never escape. Consequently, investors are rightly concerned that their investment could be obliterated overnight by an SEC action.
  • It’s federally illegal: While the Obama administration has allowed the Colorado and Washington “experiments” to continue, investors should remember that federal law is quite clear. The industry could face a big setback in 2016 when a new President is elected.
  • Valuation: While the prices have come down, the value of the companies as measured by the market capitalization remains hard to justify. While some of the companies may ultimately justify these valuations, most probably won’t.
  • Supply of stocks could increase: The publicly-traded companies are a tiny sliver of the overall industry. In the coming years, we can expect many of the private companies to enter the market and offer investors better prospects, leading to a loss of interest in many of the stocks currently trading.

 

5 Reasons for Optimism

  • Broadening support – The majority of Americans support legal marijuana, and only a tiny segment are against medical marijuana. The recent six-part editorial series by the NY Times in support of legalization will likely be viewed as a turning point in the political discussion.
  • End of the summer: Trading volumes are typically lower for penny stocks in the summer, and investor interest in the market, which has waned, could pick up again in the fall.
  • Newer, better companies: Most of the early publicly-traded companies have not delivered on their promises so far, but a second wave of companies market that appear to be of higher quality have begun to enter the market. It is very likely that some of these new entrants could IPO on the NASDAQ in 2015.
  • Fall elections: The November elections should put a very favorable spotlight on the industry and could attract more investor interest. Alaska and Oregon have ballot initiatives for legal cannabis, while Florida voters could approve medical marijuana, which would make it the first southern state to join the 23 states that have already approved programs. The end-game is federal legalization, which isn’t likely until 2020.
  • Canada: Unlike the U.S., which takes a state-by-state approach, Canada implemented a national medical marijuana program earlier this year. While it’s off to a slow start, it affords investors the opportunity to invest in fully legal producers. One company began trading earlier this year, and four additional licensed producers will begin trading soon. The kicker is that the country could possibly transition to a fully legal cannabis system in 2016, well before the U.S.

 

Bottom-line

Marijuana stocks are suitable for only the most risk-tolerant investors, as even the best names in the sector are highly speculative. Investors in the space should be very careful in this environment, as most of the stocks are likely poor investments. The industry fundamentals are strong, and the sector will likely offer opportunities to capitalize in the coming years.

Download Alan’s free report “Capitalize on Cannabis” by visiting www.GreenRushInvestor.com

Alan Brochstein

Before he became the leading “Cannabis Financial Analyst” in the marijuana industry, Alan spent numerous years on the inside of the investment industry as a portfolio manager. If you’d like to learn more about his market views or experience, check out his 600+ articles on Seeking Alpha. .

Download your copy of Alan’s special report: “The 420 Investor Guide to Cannabis Stocks” right now to get an insider’s view of why this budding industry is poised for $150 billion dollar growth and what it means for marijuana investors. This essential guide is yours absolutely FREE!

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