Should You Invest in Cannabis Stocks?

What are the risks assoicated with cannabis investing?

Should You Invest in Cannabis Stocks?
Published on Oct 7, 2020 • 3 min read
Published By: Shankar Iyer

When it comes to investing there are several options to consider. You can look to invest in stocks, bonds, real estate, ETFs, mutual funds, or even annuities. However, publicly listed companies or equities remain a popular choice due to their ability to generate long-term wealth. Stocks are also one of the most liquid instruments though they carry certain risks. 

Even in stocks, there is a multitude of investment options. You can invest in companies depending on your risk appetite and financial goals. For example, when you are young and have a long working career ahead of you, investing in growth stocks is a good option. You can afford to take chances and have enough time to learn from your mistakes. 

In the recent past, one industry that is garnering investor attention is the cannabis space. According to Statista, worldwide spending on marijuana products is expected to top $29 billion in 2020 and increase to $63.5 billion by 2024. This indicates an annual growth rate of 24% and you can see why investors are interested to buy publicly traded cannabis companies. 

However, as is the case with every investment, you need to understand the risks before you take the plunge and buy shares in cannabis companies. 

A nascent industry

While the cannabis space is expected to grow at a stellar rate in the upcoming decade, there are significant risks as well. The global marijuana industry is at a nascent stage and will have to tide over teething and growing pains. 

The current scenario can be likened to the dot-com bubble at the start of this millennium. As investors were bullish on internet companies, it soon became a crowded space with multiple players. 

After the bubble burst, just a handful of them were left standing. Though these companies become trillion-dollar giants (read Amazon and Google), it was almost impossible to pick a winner back then.

The cannabis segment is extremely crowded right now and there are a number of players fighting for market share. While a few companies have the potential to increase your wealth at an exponential rate, it is difficult to predict such a company right now. 

A capital-intensive business

Cannabis cultivation is a capital-intensive business. There are huge costs associated with developing and operating a cannabis company. Licensed producers require large-scale agriculture facilities to grow thousands of kilos of cannabis plants every year. 

These costs can increase a company’s overhead expenses significantly resulting in massive losses until they can benefit from economies of scale. The cannabis companies continue to reinvest to meet increasing consumer demand making it impossible to generate profits in the initial years. 

Possibility of dilution

A loss-making company that has to spend on capital expenditure will need to raise additional capital and fund its growth initiatives. As marijuana is still illegal in the U.S. at the federal level, access to the traditional form of debt capital is not easy. 

Pot stocks have to raise equity capital which then comes at the expense of existing shareholders, whose ownership percentage is diluted resulting in a further decline in stock prices. 

Investing in a marijuana ETF reduces risks

While there are structural issues impacting cannabis companies, its long-term growth potential remains too good to ignore. So, what do you do in such a scenario? You can look to invest in a marijuana ETF such as the Horizons Marijuana Life Sciences ETF or HMMJ. 

An ETF is an exchange-traded fund that holds a basket of stocks. Investing in the HMMJ ETF will give you access to several large cannabis companies, diversifying your risks to a large extent. While investing in an ETF will not increase your wealth at a rapid pace, it ensures you do not lose a significant amount of capital when the market turns bearish.

The HMMJ ETF’s top five holdings include Innovative Industrial Properties, Canopy Growth, GW Pharmaceuticals, Aphria, and Cronos Group that account for a cumulative 63% of the fund. 

 

If you found this piece interesting, take a look at Aurora Cannabis’ billion-dollar goodwill write-down


   

Shankar Iyer

 

Shankar has been working in the investment banking and financial services domain for over 14 years. He has completed his CA Inter from the Institute of Chartered Accountants of India a

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