Marijuana stocks have attracted a lot of attention from investors over the past couple of years. And for good reason. With 29 U.S. states legalizing medical and/or recreational marijuana and Canada considering legalizing recreational use of the drug nationwide, marijuana has become one hot commodity.
But all marijuana stocks aren't alike. Actually, there are three major categories. Here's what investors need to know about these three different kinds of marijuana stocks.
What's the most pure-play marijuana stock? Marijuana growers. These are the companies that cultivate marijuana and sell it to consumers. Most of the U.S.-based marijuana growers that are publicly traded have tiny market caps. However, it's a different story for Canadian marijuana growers.
Canopy Growth Corporation (NASDAQ:CGC) boasts the largest market cap of any marijuana grower, at more than $1.1 billion. The company is a leading supplier of medical marijuana in Canada. Canopy's opportunities and risks reflect those of most stocks of marijuana growers.
The company's opportunities lie primarily in expanded legalization of marijuana. Canopy is in prime position to profit from legalization of medical marijuana in Germany earlier this year. The company also stands to increase its revenue significantly if Canada allows nationwide use of recreational marijuana.
Canopy's risks, though, are substantial. Any bumps in the road with marijuana legalization could hurt the stock. Its valuation is also sky-high, with shares trading at nearly 30 times sales.
Several biotechs around the globe are working to develop and market drugs using key chemical components of marijuana, referred to as cannabinoids. In many cases, these biotechs technically are using synthetic forms of these chemicals, but they're still usually categorized as marijuana stocks.
The biotech primarily focused on cannabinoid development with the largest market cap is GW Pharmaceuticals (NASDAQ:GWPH). Based in the United Kingdom, GW Pharma has a market cap of $2.5 billion. While the company already has a cannabinoid on the market in several countries, GW Pharma's relatively large market cap (for a marijuana stock, at least) stems mainly from the promise for another drug that isn't yet approved -- Epidiolex.
GW Pharmaceuticals and other cannabinoid-focused biotechs must follow federal guidelines established by the Food and Drug Administration and the Drug Enforcement Agency. These biotechs could even benefit if efforts to legalize marijuana are slowed or thwarted, since legal marijuana could present a rival to their prescription drugs.
The biggest risks for companies like GW Pharma, though, are those that all biotechs face, even those not involved in cannabinoid development. There's always the potential for clinical trial setbacks, failure to win regulatory approval, and disappointing launches even if approved.
Companies in the last category of marijuana stocks don't grow marijuana, sell marijuana, or develop drugs using any component of marijuana. So why are they called marijuana stocks at all? Supply providers make growing marijuana possible, through fertilizers, hydroponics, lighting systems, and other items critical to the cannabis industry.
Scotts Miracle-Gro (NYSE:SMG) is the largest supply provider to marijuana growers. The company has moved aggressively in recent years to expand its presence in the hydroponics market, scooping up several smaller players. Many marijuana cultivators view Scotts subsidiary Hawthorne Gardening Company as the premier source for supplies.
A lower risk profile makes stocks like Scotts Miracle-Gro appealing to many investors. Scotts is growing as a result of an expanding marijuana industry. At the same time, though, most of the company's revenue still stems from other sources, primarily its consumer lawn and garden products.
However, Scotts isn't without other kinds of risks. The company competes with private-label brands of major retailers. And because it's still tied to the marijuana industry, many of the same problems that could hurt marijuana growers would affect Scotts stock also.
What's the best kind of marijuana stock?
Risk tolerance is the key determining factor for investors who are interested in buying marijuana stocks. Supply providers such as Scotts Miracle-Gro probably have the lowest level of risks. However, these stocks also don't have the growth potential that stocks such as Canopy Growth might have.
Different stocks within each category will also have varied levels of risks. With Epidiolex performing well in multiple late-stage clinical studies, for example, GW Pharmaceuticals could have less risk than biotechs with cannabinoids in early-stage development.
For some investors, the best kind of marijuana stock is no marijuana stock at all. The risks associated with these stocks are substantial and not suited for many individuals. Sometimes the hottest stocks are also the ones that can burn investors the worst.