This year began much in the same way that each of the past couple of years have begun: with cannabis stocks going through the roof.
It certainly hasn't been hard to get excited about the marijuana industry with Canada becoming the first industrialized country in the modern era to legalize recreational pot in October 2018, and Mexico looking to be just months away from doing the same. Extremely lofty sales targets being set by Wall Street ($50 billion to $200 billion in annual worldwide sales by 2030) have further fueled marijuana stock gains, with more than a dozen pot stocks gaining at least 70% in the first quarter.
But since March ended, things have changed. In fact, it could be rightly argued that the cannabis bubble has completely burst. Since the first quarter ended, practically all brand-name pot stocks have lost at least half of their value, if not more.
Cannabis stocks soared last week -- here's why
However, something pretty incredible happened this week -- marijuana stocks bounced back in a big way. Following one- or two-year lows for much of the industry on Monday, cannabis stocks rallied strongly over the following three-day period. Hypothetically speaking, an investor who bought at the close on Monday, Nov. 18, would be looking at the following gains by Thursday's close (Nov. 21):
- HEXO: Up 62%
- Canopy Growth (CGC -0.01%): Up 43%
- OrganiGram Holdings: Up 39%
- Aurora Cannabis (ACB -1.04%): Up 37%
- Cronos Group: Up 24%
That's a heck of a three-day run for these popular pot stocks, and it looks to be fueled by progress being made at the federal level in the United States.
You see, this past Wednesday, Nov. 20, we witnessed history being made in Congress. The House Judiciary Committee voted 24 to 10 to approve the Marijuana Opportunity, Reinvestment an Expungement Act, or MORE Act. This marks the first time broad-based cannabis reform legislation (and not just banking legislation) had ever made its way to the congressional floor for a vote.
As the MORE Act is currently written, it would:
- Decriminalize marijuana by removing it from the Controlled Substances Act;
- Require federal courts to expunge or review current or prior cannabis convictions; and
- Establish a 5% federal tax on legal cannabis sales that would be used to create the Opportunity Trust Fund.
To summarize, the MORE Act would essentially legalize cannabis at the federal level, while at the same time tackling a number of perceived social inequities brought on by the war on drugs.
The MORE Act already has more than 50 co-sponsors in the Democrat-controlled House, leading to the expectation that it'll pass with ease when brought to a vote by the entire House. It's this historic vote and the expectation of passage in the lower house of Congress that really ignited a fire under pot stocks.
Remember, Canadian pot stocks are essentially locked out of the U.S. market as long as marijuana remains federally illicit. If companies like Canopy Growth or Aurora were to enter the U.S. pot scene, they'd risk losing their listing status on the New York Stock Exchange or Nasdaq exchange.
Sorry, folks, but this is an awful reason to buy marijuana stocks
While it was inevitable that some sort of catalyst would stem the pummeling that pot stocks were enduring on a nearly daily basis, it's my opinion that buying into the hype surrounding the passage of the MORE Act by the House Judiciary Committee is a terrible idea.
There's no doubt that the American public, as a whole, would like to see the federal cannabis policy reformed. In back-to-back years we've seen two-thirds of respondents in Gallup's national survey support legalization. Yet, there are a number of factors that suggest actual reform has virtually no chance of occurring at the federal level prior to mid-2021, if not even later.
For one, it's as if investors are overlooking the fact that Republicans hold majority control of the Senate until at least Jan. 2021. Members of the GOP have, historically, had a more adverse view of cannabis than Democrats or Independents. Although this view has been softening in recent years, there's still a big enough gap that makes it unlikely for the Senate to round up enough votes in support of the MORE Act.
Also, don't forget about the Mitch McConnell (R-Ky.) factor. McConnell is Senate Majority Leader, and he's an ardent opponent of cannabis. He's previously blocked marijuana banking riders from being attached to legislation headed for vote, and would almost certainly block any attempt to have the MORE Act reach the Senate floor for vote.
Additionally, a 2018 survey from the independent Quinnipiac University found that cannabis isn't a highly polarizing issue in the U.S., at least not yet. Just one in eight respondents wouldn't vote for a candidate who didn't share their view on marijuana. This suggests that Republicans remain free to oppose legalization without fear of being voted out of elected office just for that view.
The point being that the MORE Act, while making history, has virtually no chance of becoming law in 2019 or 2020. This makes the buzz surrounding the MORE Act all hype with no substance.
Here are more good reasons to avoid pot stocks for the time being
Of course, there are plenty of other reasons to keep your distance from pot stocks, too.
One good reason is that very few of them are making money on an operating basis. Remove all the one-time benefits and fair-value adjustments from the equation, and you'll find an industry where losses are prevalent. Canopy Growth lost almost 266 million Canadian dollars on an operating basis in its latest quarter, with counterpart Aurora Cannabis producing an operating loss of over CA$77 million in its fiscal first quarter. In fact, Canopy Growth's share-based compensation was higher than the company's net sales!
This is an industry that's also buried under goodwill. A number of recent amendments to pending acquisitions throughout the industry suggest that pretty much all of the already-completed deals were grossly overvalued. That's a problem for the likes of Canopy Growth and Aurora Cannabis, both of which relied heavily on acquisitions to bolster their production capacity and processing infrastructure. Aurora's CA$3.17 billion in goodwill represents 57% of total assets, with Canopy's CA$1.91 billion accounting for 23% of total assets. Translation: Big writedowns may be in the offing.
There's no doubt that cannabis stocks could be significant long-term moneymakers. But thinking the industry is going to make a complete 180 anytime soon would be foolish (with a small f).