Marijuana stocks have been going absolutely gangbusters for the past several years thanks to the industry's steady march toward legalization across the globe. Several cannabis stocks, in fact, have more than quadrupled in value over the prior 36-month period. Valuations across the space, though, have started to come down in a big way. Since the start of May, for instance, the major Canadian cannabis cultivators have lost, on average, a whopping 28.8% of their value.
Digging into the details, Cronos Group (CRON -0.41%) is the only top-10 cannabis cultivator and distributor north of the border to lose less than 10% of its value during this period. Ontario-based CannTrust Holdings (CNTTQ), by contrast, posted the worst share-price performance over the last three months (down 74%) due the revelation that the company had been growing cannabis in five unlicensed rooms.
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Are these steep industrywide declines proof positive that the marijuana stock bubble has definitely burst? If so, what's the best course of action for cannabis investors?
A textbook stock market bubble
Marijuana stocks, as a whole, exhibit all the classic hallmarks of a bubble. What defines a stock market bubble? Market analysts and academicians alike broadly define bubbles as a rapid inflation and subsequent deflation in the price of a set of closely related stocks in relation to a new innovation or emerging market.
As noted, most marijuana stocks saw their valuations soar to unrealistic heights as a direct result of the decriminalization and legalization of pot in key commercial territories. Now that the initial wave of excitement has faded and quarterly earnings reports actually matter, however, valuations have subsequently pulled back from their lofty highs in a rather startling manner. That's the quintessential definition of a stock market bubble that's burst.
Despite its frothy nature, marijuana still has an exceptionally bright future from a growth standpoint -- meaning that investors probably shouldn't run for the hills during this turbulent period. In fact, the industry is now on a clearly demarcated pathway, which investors can use to guide their stock selections.
Two key investing lessons
The first key takeaway investors will want to keep firmly in mind is that the easy money has been made at this point. The marijuana stock bubble, after all, inflated largely because of pie-in-the-sky sales estimates ranging from $200 billion to $500 billion by 2030. More recent and probable forecasts, though, have global cannabis sales coming in at between a low of $50 billion to a high of $200 billion by the end of the next decade.
While even the low end forecast of this more conservative take still constitutes a ginormous market size, it pales in comparison to the $500 billion figure floated by Canopy Growth Corporation's (CGC 20.65%) former co-CEO Bruce Linton less than a year ago. Put simply, the days of blue sky valuation scenarios driving pot stock prices through the roof appear to be at an end -- especially now that the alpha dog and key opinion leader Canopy Growth has decided to modify its brain trust.
The industry, in turn, seems ready to move into the next logical stage of its evolution. What does this maturation period entail? The legal cannabis space is widely expected to be dominated by a small cadre of top players within perhaps five years' time, thanks to a healthy mix of forthcoming buyouts and bankruptcies.
In keeping with this line of reasoning, Canopy Growth seems poised to be swallowed up by its partner Constellation Brands, Cronos Group appears destined to become a subsidy of its partner Altria Group, and laggards with high production capacities like CannTrust might be snapped up by cash-flush rivals eager to control the supply side of the equation.
That brings us to the second key investing takeaway. The best pot stocks to buy in this post-bubble environment are going to be companies like Canopy, Cronos, and perhaps CannTrust that stand out as highly attractive buyout candidates. After all, the legal marijuana industry has clearly started down the path toward "big weed" -- a powerful trend that will probably prove to be irreversible.
