Why Investors Should Avoid Marijuana Stocks

Marijuana is popular. It's fully legal in two states and the majority of Americans believe that'll soon be the case nationwide. But this doesn't mean investors should jump head first into the industry.

In the middle of last year, the Financial Industry Regulatory Authority warned investors that "con artists behind marijuana stock scams may try to entice investors with optimistic and potentially false and misleading information that in turn creates unwarranted demand for shares of small, thinly traded companies that often have little or no history of financial success."

Known as "pumping and dumping," this is an old trick on Wall Street. Most recently, it was even the subject matter of a best-selling book and Oscar-nominated movie starring Leonardo DiCaprio. The subject of both was Stratton Oakmont, a Long Island-based boiler room that manipulated the price of microcap stocks in order to turn a profit.

Whether this same type of activity, or one of equally dubious nature, is now affecting cannabis stocks is impossible to say with certainty. Yet there's enough evidence of speculative frenzy, if not intentional malevolence, that investors would be wise to steer clear of associated stocks.

In the first case, many of the companies are trading for ridiculous valuations despite having little to no actual businesses behind them. CannaVest serves as an apt example. As a commentator on Investorplace.com recently observed, while its annual revenue came to $2.2 million last year, its selling and general administrative expenses added up to $2.4 million. Despite this, the company claims to have a "gross profit" of $1.3 million.

Along these same lines, some of these companies found their way to the public markets via reverse mergers, which allows them to avoid the regulatory scrutiny of an initial public offering. It's a backdoor to the equity markets, and, as a general rule, companies that employ it should be avoided like the plague.

Finally, if there was any doubt about the propriety of these companies, the recent decision by the Securities and Exchange Commission to halt the trading of shares in Advanced Cannabis Solutions, which trades on the over-the-counter market under the symbol CANN, should put said questions to rest.

To be fair, the company and its executives, two of which I spoke to earlier this year during research on an in-depth series on the industry, deserve to be given latitude until the SEC looks into concerns that "undisclosed affiliates and shareholders" unlawfully distributed the company's stock. But I, for one, wouldn't be interested in sitting around and waiting to find out. Not with Advanced Cannabis Solutions, nor any other company in the industry.

In short, it's simply too early for these companies to go public. The perils and uncertainty are too high to hoist onto the public equity markets. And, as a result, the extreme risk, and for that matter extreme reward, should at least for the time being remain with private investors who have the knowledge, wherewithal, and on-the-ground access to the companies themselves.

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Read/Post Comments (8) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 05, 2014, at 3:44 PM, OldSchoolFool wrote:

    That's the typical "Foolish" advise that only suggests the mainstream investments where few people actually achieve real profit instead of the so-called advisors and brokers.

  • Report this Comment On April 05, 2014, at 3:46 PM, OldSchoolFool wrote:

    And not only that, it will keep people from making real money because they follow most of the carnival barker bologna that this site has too offer.

  • Report this Comment On April 05, 2014, at 9:06 PM, FoolTheRest wrote:

    ^

    So I am clear, are you advocating against the advice (with a "c") in the article to avoid marijuana OTC stocks at high valuations, have questionable financials, and are the focus of pump and dump campaigns?

  • Report this Comment On April 06, 2014, at 1:27 PM, Remix20 wrote:

    While most MJ stocks would make terrible investments, there are a few companies that many are considering the better plays in the space.

    http://www.marijuanastocksweekly.com/

  • Report this Comment On April 07, 2014, at 12:08 AM, SELLmtg wrote:

    My opinion: Buy PMCM ( a marijuana co. that owns a

    marijuana store and marijuana production facility in

    Seattle, WA (Yh, finance, news 3/19, 4/1) where WA

    is 1 of the 2 states that have legalized marijuana.

    PMCM=0.0051 (as of 4/4/) and will go up higher.

    PMCM files with the SEC, PMCM is a legitimate co.

    PMCM can grow, process marijuana in its marijuana

    production facility in Seattle, WA LEGALLY.

  • Report this Comment On April 07, 2014, at 4:08 AM, Interventizio wrote:

    Not to mention the crackdown actions once the Govs find out streets will be populated by absent-minded MaryJ.-smokers.

  • Report this Comment On April 07, 2014, at 4:42 PM, Mega wrote:

    99% of these companies are pumped fraudulently and 100% of them are overpriced.

    Money doesn't grow on trees, people. Business plans by themselves are worthless. Look at the negligible assets these companies hold.

  • Report this Comment On April 07, 2014, at 7:17 PM, RationalOptimist wrote:

    This is exactly the kind of outlook that keeps the vast majority of people from making it big. Life is short. Success requires taking CALCULATED risks, not avoiding risk altogether. Yes, the pot stocks are risky (and so is life). But that doesn't mean that many of these companies will not become great success stories. It's the birth of an industry for crying out loud! There will be loads of millionaires because of what's happening here. To assume that every single of one of these 60-75+ companies are all scams in the making, destined to be shut down by the federal government is just cowardly and ridiculous. Do your "due diligence" (DD), start small, and let your money grow. Trade up with swing trading rather than investing your life savings. I like CBDS, ATTBF, MDCN, FSPM, PHOT, TRTC & CBGI. Some of the pot stocks out there you can get over 10,000 shares for less than $50 (ERBB, WNTR, LATF). Where's the risk in that? Do some serious homework first and then go for it!

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