Are you about to buy marijuana stocks? Read this first.
The legal marijuana industry is seeing green, and over the past year, marijuana stock investors couldn't be happier.
Expansion for cannabis has seemingly been around every corner. In the U.S., 28 states have legalized medical cannabis, while residents in eight states have voted to legalize recreational weed. To our north, Canada's government is currently discussing a bill that would legalize adult-use recreational pot by the summer of 2018, while south of the border, Mexico is deciding whether it will open the door for medical marijuana to thrive in a legal market.
What's this all mean? According to data from cannabis research firm ArcView, it's a massive market opportunity for businesses and investors. Last year, per ArcView, $46.4 billion in North American weed sales (which includes recreational and medical) was conducted in the black market. If the legal industry can sway a steady number of these consumers with each passing year via ongoing legalization efforts in the U.S., Canada, and Mexico, the sky could be the limit for marijuana stocks.
We certainly don't have to look far to see how excited investors are about pot stocks. Far more weed stocks than not with a market cap of at least $200 million have witnessed their valuations double, triple, or run even higher over the trailing 12 months.
The largest North American pot IPO just imploded
Demand for marijuana stocks is also increasing the likelihood that private companies will consider going public. That was the recent impetus behind MedReleaf's (LEAF) desire to go public. MedReleaf is a Canadian-based producer and retailer of medical cannabis. (Medical marijuana has been legal in Canada since 2001.)
In late May, MedReleaf priced its public offering at a little over $7 per share, or 9.50 Canadian dollars. Its IPO raised a whopping $75 million, $60 million of which came from the sale of stock from its treasury and $15 million from existing shareholders. More importantly, its debut price just north of $7 suggested a valuation of $636 million, making it the second most valuable licensed Canadian marijuana stock behind only Canopy Growth Corp. (CGC -1.02%), as well as the largest North American marijuana stock IPO of all time.
Unfortunately, things didn't work out as planned for pot investors or MedReleaf. After its first day of trading on June 7, MedReleaf's shares had sunk by 22%, marking the worst decline for a debuting stock on the Toronto Stock Exchange in 16 years, according to Bloomberg data. A number of analysts had been predicting a drop below the issue price considering that investors are having an increasingly tough time differentiating pot stock IPOs and reverse merger listings from one another.
Making matters even worse for Canadian-based medical cannabis producers and retailers like MedReleaf, Health Canada announced some major changes to its medical cannabis program less than a week before MedReleaf priced its offering. The changes mean an increase in licensed producers in Canada, which signals the likelihood of an increase in competition. That's bad news for pricing and margins for a company like MedReleaf.
The dangers of investing in marijuana stocks were just exposed
Even though we've witnessed a rebound in MedReleaf's share price since its debut-day implosion, it's pretty evident from its IPO just how risky pot stocks really are.
For starters, the volatility and emotion-driven investing we're seeing in these companies is off the scale. A good example would be Axim Biotechnologies (AXIM -2.07%), whose share price has risen by more than 3,500% in less than a year. Though the company now has Medical Marijuana, Inc. (MJNA -3.33%) in its corner -- Medical Marijuana, Inc. took a 43% stake in Axim -- it's seemingly years away from having a chance at commercializing anything in its pipeline. In fact, most of its cannabinoid-based chewing gums, gels, and ophthalmic applications haven't even begun basic phase 1 dose-finding trials yet. Investors are busy cawing over its deep pipeline and association with cannabis, but it's yet to deliver much of anything in the way of clinical evidence that it's worth anywhere near what investors are currently paying. That's scary.
The legal pot industry is also built on the prospect of expansion, which is not given throughout North America. Canadian Prime Minister Justin Trudeau has been lobbying for legal recreational weed for years without success. Conservative members of Canada's government continue to be concerned about children's access to marijuana and the potential for driver impairment if recreational pot becomes legal.
In the U.S., the Trump administration has signaled that it could get tougher on recreational cannabis, albeit no specifics have been laid out for how it will do so. However, with Jeff Sessions, an ardent marijuana opponent, as attorney general, no pot-based business in the U.S. is resting easy.
Finally, there are the ongoing losses that most cannabis stocks are contending with. Canopy Growth Corp. is one of the few recent exceptions. It's on track to turn a full-year profit this year, although it's not guaranteed to do so next year if new licensees enter the space. On the flip side, practically every cannabinoid-based drug developer is losing money, and even a few publicly traded medical cannabis producers, like Aurora Cannabis, are mired in the red.
Pot mania is beginning to cool, and there's a good chance you'll want nothing to do with the industry until we see some clear and decisive changes by the U.S., Canadian, and/or Mexican governments.