The Surprising Problem That’s Holding Cannabis Stocks Down

Marijuana collapse

The cannabis industry is the fastest-growing industry in the U.S., projected to grow to $66 billion by 2025, up from an estimated $14 billion this year. That’s the legal market, not the illicit market that is slowly being replaced.

This industry includes not just marijuana, but also CBD, which has become the hottest medical product on the planet this year (CBD is now a more popular search term than Beyoncé or Kim Kardashian).

And individual companies are thriving, all vying to become the leaders of this great, newly legal industry. The average company in my Cabot Marijuana Investor portfolio, in fact, saw revenues grow an astounding 283% in the latest quarter relative to the year before. There’s no industry that comes close to this rate of growth!

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Furthermore, some of these companies are finally turning profitable; investments are now paying off, costs are being managed, and repeat business is becoming a growing part of the story.

Yet investors in cannabis stocks are suffering; the Marijuana Index is down 55% since its March peak!

The Marijuana Index

Cannabis stocks are down 55% since March.Partly, as I’ve told my readers, this is because the sector was very hot in the first part of the year. In the stock market, whatever’s hot needs a cooling off period, so the cannabis sector’s retreat in May and June was logical.

But what’s happened since then—the erasing of all this year’s gains and more—is illogical and can only be explained by one big fact—which is this:

 Only 7% of U.S. cannabis stocks are owned by institutions. The other 93% is in the hands of individual investors.

Contrast this with the broad market, where 80% of all U.S. stocks are owned by institutions. In the broad market, these institutions, which are generally rational, provide a moderating influence that prevents stocks from getting too far out of trend—most of the time.

But when it comes to cannabis stocks, these institutions are not present to lend a moderating influence—to be the adult in the room—and there are three big reasons for that.

  1. Liquidity. These companies, despite their fast growth, are still small. In my Cabot Marijuana Investor portfolio, which is weighted (obviously) toward the best stocks in the industry, the average stock trades less than 2 million shares per day. That’s not a bad number, but because these tend to be low-priced stocks, there’s really not a lot of money changing hands. It’s rare to see more than $100 million of one cannabis stock traded in one day.
  2. Profitability. While fast revenue growth is great, most institutions want to see positive earnings, or positive cash flow. And while some cannabis companies have achieved those milestones, the majority haven’t. Those stocks in particular are at the mercy of individual investors.
  3. Legality. This may be the most important reason of all. Marijuana is still a Schedule 1 drug in the U.S. (along with heroin and LSD and Ecstasy, among others) and dealing in it is illegal under Federal law. Obviously, that is in the process of changing, but the timing of the change is unknown. And until dealing in marijuana is perfectly legal, many conservative, risk-averse Wall Street institutions will continue to avoid these stocks like the plague.

Still, the future is bright.

Cannabis Stocks are on Sale

Warren Buffett famously said that the stock market is the only place where when things are on sale, people run away. Right now, cannabis stocks on average are priced 55% lower than they were in March. Back then, investors were clamoring for the merchandise; now they’re afraid of it. It’s not logical, but neither is the stock market—in the short term.

In the long term, however, I’m very confident that investors will look back on late 2019 as a great entry point for cannabis stocks. Whether the true bottom doesn’t occur until December (thanks to tax-selling pressures) or whether it’s already occurred remains to be seen. But already, the best stocks in the sector have built bottoms, as the selling pressures have dried up and individual investors have tip-toed back in.

And those are the stocks I’m guiding my readers to in Cabot Marijuana Investor. In fact, I’ll be highlighting a couple of new recommendations in the issue coming out later this week!

To learn their names, click here.

Timothy Lutts

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