High on Pot Stocks? Here's How Not to Get Burned

Insert joke here about your portfolio going up in smoke.

Jun 15, 2014 at 10:19AM

An outfit called "PotStockGuru" recently sent around a promotional email touting a stock on the basis that "the new Pot Stock Market is the hottest thing since the dot-com boom!"

It is curious they should choose the dot-com boom as their selling point. To anyone who remembers it correctly, the dot-com boom is more of a cautionary tale than something to relive. In any case, this email was interesting just because it so vividly illustrated the type of investment pitch that consumers should treat with maximum suspicion.

The trouble with marijuana stocks and "hot" stock tips
Here are some caveats about hot stock tips in general -- and marijuana stocks in particular:

  1. Consider the source. It is not clear who "PotStockGuru" is, and that is a problem. The reputation, track record and resources of whoever is making a recommendation matter a great deal. If you do not know where it is coming from, you do not know how good the recommendation is.
  2. Consider the motive. Even when the recommender is well-known -- say, a prominent TV personality -- you should consider the motive behind the recommendation. Are they giving you advice for your benefit, or for the benefit of a stock they might just happen to own?
  3. Beware of penny stocks. The recommendation from PotStockGuru was for a penny stock. The SEC defines a penny stock as any whose price is below $5 a share. In the case of this recommendation, the description was especially apt because the stock in question was selling for exactly one penny. Anyway, the SEC cautions that penny stocks are illiquid and highly speculative. Now that's stock advice worth heeding.
  4. Be cautious of "the next big thing." The legalization of marijuana in a couple of states has led to a buzz that goes beyond a craving for Twinkies. The investment buzz is that this new market will create a vast new profit potential for companies legally involved in cultivating, distributing and retailing pot. That may prove to be true, but buying into that type of big-picture thesis can be treacherous. During the 1990s Internet boom, scores of companies whose only real connection to the Internet was having a corporate site that placed ".com" after their official names in the hopes their stocks would get swept up in the hype. The SEC recently issued warnings to several companies trying to cash in on what has been dubbed the "green rush," because the only connections these companies seem to have to marijuana are names that would make a stoner giggle.
  5. Is there a business model or just hype? Even if you find a stock that is actually in the legitimate marijuana business, that connection alone is not enough. There needs to be a business model that will let them operate at a profit and sustain an advantage against competition.
  6. The legal ground is shaky. Remember, the federal government still considers pot illegal, and the tide supporting legalization at the state level could turn back around. A few legislative and enforcement actions could quickly wipe out this market.

Finally, beware any stock recommendation that uses exclamation points. This email had several; serious analysts typically do not use them. Imagine each exclamation point as the needle on a BS detector. On this particular recommendation, all the needles were pointing straight up.

This article originally appeared on Money-Rates.com.

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