For all the challenges that marijuana stocks have faced in the past year, including a lack of profitability and analysts being bearish on the industry, there's been no shortage of investors who have been willing to buy shares of cannabis companies despite the risks involved. The biggest risk for any cannabis investor today centers around how sensitive the stocks are and how volatile they can be in response to new developments in the industry, or just analyst opinions. This volatility shouldn't be ignored, as investors could see their portfolios lose significant value in a short amount of time.
Significant price changes are par for the course
It's not uncommon to see big swings in price from one day to the next in pot stocks, even among some of the bigger names in the industry. Canopy Growth (CGC -3.01%) and Aurora Cannabis (ACB -6.81%) have taken their shareholders on a roller-coaster ride this past year, and that's been true for the industry as a whole. Unfortunately, for many investors, the ride has been headed in one direction: down. Aurora lost more than 60% of its value this year, while Canopy Growth declined a more modest 34% in 2019. The Horizons Marijuana Life Sciences ETF, which holds a broad collection of pot stocks, has fallen by 40%.
But it's not just that pot stocks have fallen that makes them risky; it's the large swings in value that means investing in them is especially dangerous. As of Dec. 26, Canopy Growth saw its share price move by more than 10% a total of 10 times during the past year. Only half of those occurrences have been positive. Aurora, despite its worse showing this year, has had the same number of 10% moves during the year, but seven of those times were positive, with just three being negative.
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When looking at movements of more than 5%, the ratio of positive to negative movements for both stocks remains at or near 50%. The most telling metric is that when looking at all the days analyzed, nearly one-quarter of Canopy Growth's trading days (24%) saw its closing price move by more than 5% from the prior day's close. Aurora has been a bit more modest, with 19% of its trading days seeing the same level of movement.
To put this into perspective, the S&P 500 increased by more than 3% just once during the same period. While a broad holding of stocks will see less volatility, the Marijuana Life Sciences ETF saw its value move by more than 5% a total of 14 times. That's 5.6% of its total trading days during the period analyzed.
Why is there so much volatility?
The largest single-day move for Canopy Growth happened on Nov. 21, when the stock jumped 18%. For Aurora Cannabis, it was Nov. 20, when its value went up by 15%. The big news around that time was that the House of Representatives approved a bill that would legalize marijuana federally and would no longer make it a Schedule 1 substance. Canopy Growth got an additional boost on news that it was upgraded by analysts at Bank of America.
Although the bill to legalize pot federally is in its early stages, and it's a long shot to pass given that Senate Majority Leader Mitch McConnell remains opposed to the legalization of marijuana, news of the bill was enough to send pot stocks into a frenzy. Marijuana stocks are very sensitive to new developments, which can move very suddenly. While investors can earn quick returns, they can also suffer significant losses as well. When one analyst at GLJ Research said in December that Aurora's "equity holds no value," the stock proceeded to fall more than 4% the following day. A few weeks ago, U.S. cannabis company Trulieve fell 12.6% in one day when a short-seller report accused the company of being a fraud. At one point the stock was down 23% amid the panic as trading volumes soared to more than 3.5 million, more than 10 times the volume the stock saw over the past two trading days.
Why should investors care?
Market volatility is something all investors have to become accustomed to when buying shares. However, the level of movement pot stocks have experienced over the past year is well above what's normal for the markets as a whole, and it makes investing in cannabis very risky. Not only are valuations dropping, but the swings can be very significant.
Given the challenges the industry is facing today and the volatility involved, it's a very high-risk sector to be investing in right now. That's something investors should take into consideration when putting their money into marijuana stocks, as there's a very real danger their investments could lose significant value.
