Marijuana: The Most Dangerous Investment You Can Make?

Marijuana stocks have soared this year -- but is there more froth than substance behind these moves?

Apr 5, 2014 at 11:04AM

To put it mildly, marijuana stocks have been smoking hot this year as the lines surrounding the legality of the drug and public perception have blurred a bit.

While still classified as a class 1 illegal substance by the U.S. federal government, close to two dozen individual states have now allowed the use of medicinal marijuana for select ailments, while voters in both Washington state and Colorado voted in 2012 to allow for the recreational use of marijuana (under one ounce) within the confines of a person's residence. In spite of the stark contrast with federal law, the U.S. government has repeatedly claimed that it would not superimpose federal law within Washington or Colorado.

In addition to the above change, public perception of marijuana has shifted from a majority opposing approval of the drug even a decade ago to something closer to parity, or perhaps even in favor of approval, just depending on the poll source.

According to a Pew Research Center telephone survey released earlier this week, three-in-four respondents, regardless of their personal belief on marijuana legalization, believe the drug will eventually be legalized on a federal level. Within this particular study, 39% of respondents believed marijuana should be legalized for personal use with 44% believing it should be legal for medicinal use.

By comparison, a Gallup poll conducted in October 2013 reported that, for the first time in the 45 year history of the poll concerning marijuana legalization, the majority of respondents favored legalization (58%). 

In sum, marijuana is no longer a cut-and-dried illegal drug as it once was – and that's got investors thinking that, if approved on a federal level or even further on a medicinal level by the remaining states, it could become the best-selling drug in the United States.

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Source: Brett Levin, Flickr.

Is this the most dangerous investment on Wall Street?
The result has been dramatic rallies in the share price of cannabis-based stocks since the beginning of the year, which is when Colorado and Washington's recreational use laws when into full effect. Yet, many of these cannabis-based companies have unproven business models, no revenue, or are seriously lacking in the revenue growth department. Even after a monumental drop in the price of marijuana stocks over the past couple of weeks, these companies could still currently represent the most dangerous investments on Wall Street.

A case could be made that even the most high-profile cannabis company can be viewed as grossly overvalued – that being U.K.-based GW Pharmaceuticals (NASDAQ:GWPH).

Sativex

Source: GW Pharmaceuticals.

GW Pharmaceuticals has a unique way of approaching its drug development process. Having discovered five dozen different cannabinoids and the natural cannabinoid receptor system in humans, GW believes it can use those receptors to help regulate biologic pathway functions. The result is the development of Sativex, a drug utilizing two cannabinoids (THC and CBD) to treat spasticity in MS patients that's approved in 11 countries. All told, though, despite having a potentially lucrative partnership with Otsuka Pharmaceuticals, Sativex brought in just $3.7 million in sales in 2013, down 14% from the previous year. Total 2013 revenue for GW fell roughly 18% to $44.2 million. Considering that GW Pharma is valued in excess of $800 million and is still losing quite a bit of money, this is potentially a frothy valuation.

But, it gets much loftier than GW Pharmaceuticals if you're willing to look at some of the larger over-the-counter marijuana stocks.

Take CannaVEST (NASDAQOTH:CANV) as a perfect example. CannaVEST shareholders have seen their share price climb from roughly $10 per share to as high as $201 in just a few months (implying roughly a $6 billion valuation). Sure, shares have crashed by over 80% from their intraday highs, but the company is still worth nearly $1 billion. But there are a number of red flag warnings about this supplier and marketer of hemp-based products.

To begin with, CannaVEST has generated a measly $2.2 million in revenue over the previous 12 month period. Of course, even that revenue number may be called into question since the company recently reported to the SEC that its quarterly reports for the first three quarters in 2013 "should no longer be relied upon because of errors." Leaving the accounting issues to the side, you may be asking yourself, "Why isn't a hemp-based products supplier outperforming in this environment?" I'd venture a guess because the company was previously called Foreclosure Solutions until Jan. 2013 and appears to have completely shifted its business model over the past couple of years from saving homeowners from foreclosures to supplying hemp-based products. Speaking for myself, that sort of transition doesn't exactly inspire a lot of confidence from an investing standpoint.

Need more proof this could be a bubble? How about Advanced Cannabis Solutions (NASDAQOTH:CANN), a $400 million over-the-counter leaser of growing space to licensed marijuana business operators.

On paper the business model might sound intriguing, but dig a bit deeper into the financials and circumstances currently surrounding the company and you'll probably change your tune. Despite shares rising 20-fold over the past year, Advanced Cannabis Solutions, which refers to itself as a developmental-stage company, delivered just $455 in revenue in its quarter ended Sept. 30. That's not a misprint – it really was just $455, coupled against a net loss of $472,016!

As if that wasn't enough to scare every value investor away, Advanced Cannabis Solutions' trading was also halted last week by the Securities and Exchange Commission following an inquiry by the regulatory agency of potentially unlawful distributing activities by shareholders, as well as undisclosed affiliates. Not to mention, it also filed for an extension of its 10-K because it failed to file its annual report on time! Shares aren't due to be unsuspended until April 9.

Up in smoke
In sum, this sector is ripe with speculation, but that doesn't mean marijuana stocks will live up to anything resembling the hype that surrounds them. While higher-profile non-OTC names like GW Pharma are certainly worth monitoring, there appear to be few more dangerous bets on Wall Street at present than untested and unchartered marijuana stocks – especially those trading on the more loosely regulated over-the-counter exchanges. Do yourself a favor and allow the results from these companies, not the actions of day-traders, to influence your investing habits in this sector moving forward.

Marijuana stocks have soared this year, but they may not be able to hold a candle to this top stock in 2014
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool has no position in any companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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