Beginner's Guide to Investing in Marijuana Stocks

Everything you need to know to get started with investing in marijuana stocks.

Keith Speights
Keith Speights
Mar 4, 2019 at 10:43AM
Health Care

Are you interested in investing in marijuana stocks but don't know the best way to get started? Don't worry, we've got you covered.

Marijuana stocks are super-hot right now. That's understandable considering the growing number of countries and states that have legalized pot in some form. Some project that the annual global marijuana market could be worth $150 billion or more within the next 10 to 15 years.

Of course, hot stocks can sometimes be too hot to handle. But even an investor who's new to marijuana stocks can learn what to do and what not to do.

This beginner's guide to investing in marijuana stocks will address the important things that you need to know, from the basics of the marijuana industry to the risks involved with investing in marijuana stocks. And, yes, we'll delve into which marijuana stocks look like the best picks for 2019, too. Read on and you'll be armed with all you need to know to participate in the "green rush" of the cannabis industry. 

Marijuana leaf in a shopping cart

Image source: Getty Images.

Basics about the marijuana industry

Marijuana has been used for thousands of years, primarily for two purposes: as medicine and for getting high. That's still the case today. But for much of the last century, marijuana has been illegal in most of the world for either purpose.

The dynamics are changing rapidly, though. Medical marijuana is now legal in more than 30 countries. Recreational pot is currently legal in only a handful of countries, but that number could grow also. 

Marijuana remains illegal at the federal level in the U.S. However, more than 30 states have legalized medical marijuana. U.S. territories Guam and Puerto Rico also allow the legal use of medical marijuana. Several of these states plus the District of Columbia have legalized recreational marijuana. More states are considering legalizing recreational pot as well

While U.S. federal laws still prohibit the use and sale of marijuana, hemp was legalized at the national level in December 2018. Both marijuana and hemp are made from the cannabis plant. The big difference, though, is that hemp contains very low levels of tetrahydrocannabinol (THC) -- the primary chemical in cannabis that causes individuals to get high.

Both marijuana and hemp contain another important chemical ingredient, cannabidiol (CBD). CBD isn't psychoactive like THC. It has demonstrated benefits in treating forms of epilepsy and could have other therapeutic uses such as relieving anxiety and insomnia and helping reduce inflammation. 

A wide variety of products are made from marijuana. These include cannabis flower, CBD oils, edibles, cannabis-infused beverages, concentrates used in vaping, creams, and lotions. The marijuana industry includes businesses that operate throughout the supply chain involved in making and marketing these products.

How to invest in marijuana stocks

Now that you know some basics about the marijuana industry, let's dive into some of the nuts and bolts of investing in marijuana stocks. First, it's important to note that there are three primary kinds of marijuana companies:

  • Marijuana growers -- companies that cultivate marijuana (typically in indoor facilities and greenhouses).
  • Cannabis-focused biotechs -- companies that develop prescription drugs based on ingredients found in cannabis.
  • Providers of ancillary products and services -- companies that provide key products and services to the marijuana industry, including consulting, distribution, hydroponics, lighting systems, and packaging. 

You should also remember that the principles that apply to investing in any kind of stock also apply to marijuana stocks. Check out a company's management team with a special focus on top executives' track records in the industry or in similar industries. 

Research the company's strategy for growth and expansion. For example, one company might envision growing primarily through acquisitions, while another might prefer to grow organically.  

Look at the competitive landscape and find out how the company intends to differentiate itself from rivals. Identifying a company's top partners is also important since they can help it be more competitive. 

See if the company is profitable yet. Keep in mind that the marijuana industry is still in its early stages, so many companies won't yet be profitable. That's not necessarily a bad thing at this point. However, try to determine how quickly the company expects to become profitable and how it will fund operations in the meantime. 

Most, if not all, of this information can usually be found on companies' investor relations websites. The dynamics of the industry can change quickly, though. So it's also important to stay up-to-date on the latest marijuana news and analysis in this emerging market. 

For marijuana stocks, in particular, it's critical to understand which geographic markets a company is targeting. For example, some smaller marijuana growers focus only on the Canadian market. Larger marijuana growers are more likely to have operations in Europe and Latin America in addition to North America. Some providers of ancillary products and services primarily serve U.S. marijuana businesses. Each geographic market has a different opportunity and different risks (which we'll discuss a little later).

Top marijuana stocks to buy in 2019

For now, most of the biggest marijuana stocks are based in Canada. That's primarily because Canada was the first major economic power to legalize recreational marijuana. However, there are also quite a few U.S. marijuana stocks that are worthy of consideration. There are several top marijuana stocks to buy in 2019. Below are five that include both U.S. and Canadian companies. 

Company

Type 

Country

Constellation Brands (NYSE:STZ)

Marijuana grower (via partnership) U.S.
Innovative Industrial Properties (NYSE:IIPR) Ancillary products/services provider U.S.
KushCo Holdings (NASDAQOTH:KSHB) Ancillary products/services provider U.S.
OrganiGram Holdings (NASDAQ:OGI) Marijuana grower Canada
Origin House (NASDAQOTH:ORHOF) Ancillary products/services provider Canada

Constellation Brands

Constellation Brands is best known for its premium beers including Corona and Modelo. However, the company's $4 billion investment in Canopy Growth (NYSE:CGC) in 2018 put Constellation front and center in the global marijuana industry.

The duo of Constellation and Canopy is arguably the strongest player in the marijuana market. Constellation brings ample financial resources and a track record of building successful consumer brands. Canopy has been a leader in the Canadian marijuana market for several years, and its production capacity dwarfs that of nearly all of its rivals.

There are other close partnerships between marijuana growers and companies with primary operations outside of the cannabis industry. However, Constellation has made the biggest investment so far. That investment has enabled Canopy Growth, among other things, to move forward into the U.S. hemp market more quickly than its peers.

Why not buy Canopy Growth instead of Constellation? Mainly because Constellation gives you the best of two worlds. The company continues to dominate in the premium beer market and generate strong profits. But Constellation's 38% stake in Canopy Growth gives investors a way to also profit from the boom in global marijuana markets.

Innovative Industrial Properties

Innovative Industrial Properties is organized as a real estate investment trust (REIT) and owns properties that it leases to medical marijuana businesses. REITs, by the way, are investment companies that own income-generating real estate properties. There are a couple of nice benefits for investors in owning a marijuana-focused REIT.

First, it provides some diversification. Innovative Industrial Properties owns 11 properties that it leases to eight customers. The REIT can be successful even if one or two of its customers aren't successful.

Second, REITs are required to distribute at least 90% of their taxable income to shareholders as dividends. Innovative Industrial Properties' dividend yield should continue to increase as its profits grow.

And those profits should grow. Innovative Industrial Properties currently leases properties in 10 states. Four of those states are projected to have marijuana markets of at least $1 billion by 2022. The company should have plenty of room to expand in these states and elsewhere.

KushCo Holdings

KushCo Holdings ranks as the leading supplier of packaging solutions to the U.S. cannabis industry. The company manufactures a variety of products -- including pop-top bottles, tubes, and vaporizer cartridges -- designed to meet the needs of cannabis growers and dispensaries.

While KushCo's sales are skyrocketing, the company isn't profitable yet. One big reason why that's the case is that KushCo continues to invest in expansion. KushCo has also experienced some growing pains in the form of higher air freight and quality control costs associated with meeting the surging demand for its products.

However, KushCo should be able to eventually reach sustainable profitability as it capitalizes on the growth opportunities of the marijuana market in the U.S. and in other countries. KushCo has especially targeted Canada and Europe as opportunities for growth.

The U.S. legalization of hemp also should provide a nice growth opportunity for KushCo. Several of the company's packaging products could enjoy higher demand as a result of hemp legalization. In addition, KushCo Energy, which markets solvents used in extracting CBD from cannabis, should experience a boost in sales from increased demand for hemp-based CBD.

OrganiGram Holdings

OrganiGram Holdings is a Canadian licensed marijuana producer that targets the country's medical and recreational marijuana markets. The latter market is where the real excitement for OrganiGram is these days. The company has supply agreements with provincial crown corporations (government-owned companies in Canada) or retail partners for recreational marijuana in nine of Canada's 10 provinces.

Although Canada is where OrganiGram currently makes its money, the company isn't limiting itself to its home country. OrganiGram teamed up with Alpha-Cannabis to go after the big medical marijuana opportunity in Germany, which claims the largest legal marijuana market outside North America. The company also made a significant investment in Serbian hemp producer Eviana.

OrganiGram doesn't rank among the biggest Canadian marijuana growers in terms of capacity. However, the stock looks more attractive than most of its peers in several ways. For one thing, unlike many Canadian marijuana growers, OrganiGram has consistently posted profits in recent quarters. The company also has one of the lowest production costs in the industry -- a key reason why OrganiGram has been profitable while many of its rivals weren't.

And while OrganiGram's price-to-earnings (P/E) ratio is high compared to stocks in other industries, the stock is a bargain relative to most marijuana stocks. The stock's valuation looks especially appealing when you compare how much annual production capacity per dollar invested you get with OrganiGram versus that of larger Canadian marijuana growers. 

Origin House

Origin House is based in Canada, but the company's primary operations are in the U.S. The company started out with a business model centered on royalty streaming, which provides financing to marijuana businesses in exchange for a percentage of future revenues. Now, however, Origin House is a distributor of cannabis products, including several of its own brands.

The company's main focus is on California. The state has the biggest legal marijuana market in the world. And Origin House is the biggest distributor of cannabis products in the state, reaching around 70% of the dispensaries there.

California's legal recreational marijuana market opened in 2018. During the market's first year, there were plenty of bumps in the road, many of which were related to burdensome regulations and high tax rates. But the state appears to be resolving some of the issues, paving the way for Origin House to grow even more in California.

Meanwhile, Origin House is also looking to grow in other markets. The company acquired 180 Smoke, a major Canadian vape retailer, in a deal that opens the door for expansion of its own brands into the Canadian recreational pot market. In addition, Origin House could seek to replicate its distribution model in other states down the road.  

Investing in marijuana exchange-traded funds

You don't have to buy individual marijuana stocks to profit from growth in the cannabis industry. Exchange-traded funds (ETFs) provide a way to buy multiple stocks in one fell swoop. And there are a couple of marijuana-focused ETFs.

The Horizons Marijuana Life Sciences Index ETF (TSX:HMMJ) tracks Arcview Market Research's North American Marijuana Index. The index includes mainly marijuana or hemp companies. This marijuana ETF trades on the Toronto Stock Exchange, but U.S. investors can buy shares on the over-the-counter market.

The ETFMG Alternative Harvest ETF (NYSEMKT:MJ) tracks the Prime Alternative Harvest Index. While this index includes many marijuana or hemp stocks, it also includes some tobacco-related stocks. The ETFMG ETF is listed on the New York Stock Exchange's Arca exchange.

Although marijuana ETFs provide diversification among a group of marijuana stocks, they do have a few drawbacks. The expenses investors have to pay with the two marijuana ETFs are higher than those of most ETFs. The ETFs also don't have significant holdings in marijuana stocks that are primarily focused on the U.S. 

What are the risks of investing in marijuana stocks?

Before buying marijuana stocks or ETFs that hold marijuana stocks, you definitely need to be aware of the risks associated with investing in the marijuana industry. Some of these risks are common to stocks of any industry, and include potential threats from competition and the possibility of scandals. But there are some risks that are especially applicable to marijuana stocks.

The market caps for most marijuana stocks are very high compared to their historical sales. A lot of their valuation hinges on expectations of tremendous growth. If this growth isn't achieved as quickly as possible, their share prices could plunge.

Many marijuana companies aren't profitable yet. As a result, they must resort to issuing new shares to raise the cash needed to fund operations. The issuance of new shares, though, causes dilution in the value of existing shares.  

How does dilution hurt shareholders? Suppose a company has 10 million outstanding shares -- the total number of shares investors own, including those held by company insiders -- trading at $50 per share. That would give the company a market cap of $500 million. If you own 1 million shares, your investment is worth $50 million. If the company issues 10 million new shares and the market cap remains constant, each existing share would be worth $5 rather than $10 because of the impact of dilution. And your investment, which was originally worth $50 million, would now be worth only $25 million. 

The stocks of marijuana companies that operate in the U.S. face the risk that the federal government could opt to enforce federal marijuana laws in states that have legalized medical or recreational marijuana. Although this threat doesn't appear to be too great, there have been some conflicting signals from the Trump administration

Should you invest in marijuana stocks?

The question that each individual must answer on their own is whether or not to invest in marijuana stocks. As you might expect, the answer to that question depends primarily on your tolerance for risk.

Marijuana stocks definitely present high-risk, high-reward propositions. But while the risks are real, the rewards may or may not be realized.

There are ways to reduce risks to some extent. As mentioned earlier, marijuana ETFs provide diversification across multiple marijuana stocks. Stocks of companies like Constellation Brands that have primary operations in other industries also can lower your risk level. But even taking these alternatives doesn't eliminate all risk.

If you decide to invest in marijuana stocks, you will probably want to start out with a relatively small position. If your assumptions pan out, you can add more shares later. That's a smart strategy for beginning and expert investors alike.