Billions of dollars are shifting from the black market to legal marijuana marketplaces and that's sent marijuana stocks soaring to new highs. However, there's increasing concern the economy will weaken because of interest rate increases and trade wars, and if so, pot stocks could tumble. If there's a widespread sell-off in marijuana stocks, here's what you should do.

Don't let fear determine your next move

We're hardwired to avoid danger and it doesn't matter if that danger presents itself in the form of a falling account balance or a raging rhinoceros. However, panicking isn't a recipe for successfully navigating the stock market.

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Instead, a level head can pay off. Instead of reacting to the latest price quote, a better approach is to focus on the long-term opportunity that's associated with the marijuana market. Consider the following points:

  • Marijuana sales in Canada total roughly 6 billion Canadian dollars annually.
  • U.S. marijuana sales are estimated to be $50 billion per year.
  • Global spending on marijuana is forecast at $150 billion annually.
  • Legal marijuana sales may eclipse $200 billion in 15 years. 

Most of Canada's spending remains on the black market, but that's changing following the opening of its recreational market last October. In the fourth quarter, consumer spending on marijuana in the legal market jumped to CA$307 million from CA$137 million in the third quarter.

The recreational market opening caused illegal sales to fall 9% in the quarter, yet black-market sales still account for about 80% of the marketplace. That suggests a significant opportunity remains to be tapped by top marijuana stocks, including market share leaders Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB). Last quarter, both companies reported breakneck sales growth that ought to continue in 2019.

Company Net Revenue, Most Recent Quarter Net Revenue, Prior-Year Quarter Year-Over-Year Change
Canopy Growth CA$83 million CA$21.7 million 282%
Aurora Cannabis CA$54.2 million CA$11.7 million 363%

DATA SOURCE: QUARTERLY CORPORATE FILINGS.

The opportunity outside Canada is even bigger. Total legal marijuana sales in the U.S. last year were just $8.4 billion, according to GreenWave Advisors' Matt Karnes, which means over 80% of America's market is still being conducted in the shadows.

Marijuana remains illegal federally in the U.S., but two-thirds of Americans support legalization and lawmakers are listening. There are 33 states with pro-pot laws on the books now, including 10 states that have given the OK to recreational markets. Furthermore, bills are planned for Congress that could someday pave the way to eliminating the federal ban on marijuana.

The momentum isn't limited to North America, either. Germany's national medical marijuana market opened in 2017, suggesting Europe is ripe for marijuana reform. Australia's medical marijuana market is in its infancy, too. 

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Focus on quality

It doesn't matter if you already own marijuana stocks or you're considering them for the first time: Quality is key.

Laws hamstring U.S. companies from listing on the major U.S. stock exchanges and they restrict access to banking services. Therefore, U.S. pot stocks have a tougher time accessing the financing necessary to boast best-in-class balance sheets. Additionally, because U.S. stocks trade on the less-liquid and less-transparent over-the-counter market, their stock prices can be more volatile and financial statements more opaque than their Canadian counterparts, making them riskier to own.

Instead of concentrating on U.S. companies, focus on the Canadian companies that have the deepest pockets, the most potential grow capacity, and the best product mix.

For instance, Canopy Growth and Aurora Cannabis captured over 30% and about 20% of Canada's recreational market in Q4, respectively. They're both expected to have over 500,000 kilograms of annual production capacity and each has taken steps to establish footholds outside Canada. Furthermore, both companies are among the biggest medical marijuana providers in Canada and each derives significant sales from high-margin extracts, rather than low-margin dried marijuana flower. Clearly, Canopy Growth and Aurora Cannabis are top marijuana stocks, but Canopy Growth is arguably the higher-quality company because it has the industry's best balance sheet. Last year, beer and spirits giant Constellation Brands invested $4 billion in Canopy Growth, giving it the deepest pockets in the industry.

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Stay objective

If you're concerned you don't own the highest-quality marijuana stocks, then it might be time to take an honest look at the stocks you do own. An objective view of your holdings should include considering the reasons why you bought the stock and if the company's on solid financial footing.

Ask yourself: Are the catalysts that led to me buying this stock still intact, or are they at risk? Is the company losing money? If so, does it have enough cash on its balance sheet to remain solvent if its business outlook softens? If answering these questions raises more questions than answers, then it could be time to rethink how much of your portfolio is exposed to those stocks and if your money might be better invested in a higher-quality marijuana company.