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The Cannabis Stock Bubble Is Bursting: 3 Things You Need to Know

By Sean Williams - Oct 7, 2019 at 7:21AM

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Pot stocks are going up in smoke, but this was expected.

It's finally happened. After more than three years of the marijuana industry delivering green for their shareholders, the cannabis stock bubble has burst.

While there's no official or concrete definition that describes when the party has ended for a hot industry, I'd call the nearly 50% decline in the Horizons Marijuana Life Sciences ETF -- the first exchange-traded fund focused on cannabis -- over the past six months pretty compelling evidence that something is amiss. The Horizons Marijuana Life Sciences ETF holds more than five dozen pot stocks of various weightings, so it's a pretty good indicator of industry sentiment and performance.

Were that not evidence enough, the month of September generated only six cannabis stocks that rose in value out of the 59 Yours Truly tracks. What's more, just three pot stocks are higher over the trailing 12 months.

There's little denying that the marijuana bubble has burst. But it's important that you understand some of the nuances surrounding this precipitous decline. Here are three things you need to know.

A person using a pin to pop a bubble with a dollar sign inside of it.

Image source: Getty Images.

1. This was expected

First of all, investors should understand that the bursting of the cannabis bubble was expected. Over the past quarter of a century, we've witnessed a number of next-big-thing investments come to the forefront, such as the internet, genome decoding, business-to-business commerce, blockchain, and 3D printing. In each and every instance, hyperbolic moves in the companies underlying these trends failed, eventually paving the way for a precipitous decline.

The thing to realize about nascent industries is that they all need time to mature. And yes, even an industry that's existed for decades in the black market needs time to mature. Prior to Canada, no industrialized country in the world had given the green light to recreational marijuana, meaning Canada's federal government and investors are sort of learning as they go. Suffice it to say, there are going to be hiccups along the way.

To our north, Canada has been contending with cannabis supply issues since day one of adult-use legalization on Oct. 17, 2018. These shortages have been complemented by Health Canada being bogged down by a mountain of cultivation and sales license applications.

Meanwhile, in the U.S., high tax rates in select states (ahem, California) have stymied the legal industry and sent consumers back to the black market. It's pretty evident that the marijuana industry needs some time to mature.

A dollar sign shadow on a large pile of cannabis leaves.

Image source: Getty Images.

2. The long-term growth trajectory for marijuana remains in place

However, the second thing you should understand is that pie-in-the-sky growth estimates for the pot industry over the long run are still very much in play. Canada's supply problems and licensing backlogs are all solvable problems. Likewise, it wouldn't be surprising to see select U.S. states tinker with their marijuana tax rates to entice consumers into legal channels. Nothing about these early stage problems represents a long-term concern for the marijuana industry.

And make no mistake about it, some of Wall Street's growth projections for the legal pot industry are enormous. The low-end of the spectrum suggests that worldwide weed sales will hit $50 billion by the end of the next decade. That compares to investment firm Stifel, which has forecast $200 billion in global cannabis spending in a decade. For context, global sales were a mere $10.9 billion in 2018, suggesting that the compound annual growth rate for legal weed would be as high as 27% per year if Stifel's estimate proves accurate.

Also bear in mind that the U.S. will be responsible for a significant chunk of these sales. Estimates suggest that the U.S. will comprise between a third and half of worldwide weed sales by 2030.

A person holding a white puzzle piece with a question mark drawn on it.

Image source: Getty Images.

3. It's unclear what companies will ultimately be leaders

Lastly, while this is probably an unpopular opinion, investors should realize that it's far too early to know which pot stocks are going to be the long-term winners and/or leaders in the industry. History tells us that some of the biggest long-term gainers in next-big-thing industries are small-cap stocks today. That means the Canopy Growth's of the weed industry may not make for the best investments.

So, what should you focus on as a cannabis stock investor? While there's clearly a lot still to be sorted out as the marijuana industry matures, focusing on small-cap pot stocks with apparent competitive advantages is a smart way to set yourself up for future gains.

Take Flowr (FLWPF 5.26%) for instance. Flowr is a company that's been beaten down in recent months by a common stock offering, as well as its decision not to uplist to the Nasdaq, despite being approved to do so. However, Flowr's Kelowna campus in British Columbia is set to produce at least 50,000 kilos of premium and ultra-premium quality weed when at full operating capacity. Competition among premium and ultra-premium growers is minimal, which should allow for strong pricing power and juicy margins.

Furthermore, Flowr recently completed the acquisition of Holigen and its Aljustrel outdoor grow farm in Portugal. While having an outdoor grow farm isn't unique, the Aljustrel grow farm is capable of 500,000 kilos a year of peak output, which is an incredible amount of output from one facility for such a small company, in terms of market cap.

The Planet 13 SuperStore in Las Vegas, Nevada.

The Planet 13 SuperStore in Las Vegas, Nevada. Image source: Planet 13.

Planet 13 Holdings (PLNH.F 0.00%) is another example of a company with comparative differences. Planet 13's SuperStore in Las Vegas is the largest marijuana dispensary in the world. When complete, it'll house a coffee shop, pizzeria, events stage, and consumer-facing processing center, and span a total of 112,000 square feet. That's bigger than the average Walmart, for context.

And it's not just the size of the SuperStore that makes it a go-to for cannabis enthusiasts. Planet 13 has self-pay kiosks in its store to speed along the buying experience for return customers, and has a sizable immersion station for users to acquaint themselves with the product. There's simply nothing like what Planet 13 is doing, which gives it an intriguing advantage moving forward.

If investors think long term, then the bursting of the cannabis bubble now won't be a big deal.

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