Investing in cannabis stocks is not for the faint of heart. The industry can take investors on a roller-coaster ride, and it can be a nightmare for those who are looking for stable, long-term growth. That said, this new space has a lot of potential, especially as more U.S. states legalize pot and countries around the world continue to loosen marijuana laws. In February 2020, Grand View Research projected that the legal marijuana market would grow to reach $73.6 billion by 2027 (in 2018, it was worth $10.6 billion).
But before you consider investing in cannabis, there's one risk that you have to be wary of -- yet willing to accept:
Pot stocks can crash without warning
Large, single-day declines are not uncommon for cannabis stocks, and there's no way for investors to prepare for them. When the CannTrust scandal broke nearly a year ago, it came out of nowhere, and the stock went from more than $5 to less than $2 in weeks. Twice during the month of July, the stock fell by more than 20%.
More recently, iAnthus shares fell off a cliff in April when the New York-based cannabis company defaulted on an interest payment, saying that it's facing "liquidity constraints." With cash flow heavily on the minds of cannabis investors, it's perhaps not shocking that the stock crashed. What was shocking was just how bad it was: In one day, the stock fell by a whopping 62%.
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But it doesn't have to be insolvency or the risk of bankruptcy that sends pot stocks cratering. Disappointing quarterly results and failure to meet forecasts can lead to tailspins as well. When Canadian pot producer HEXO announced in October that it was pulling its forecast for the year as a result of "uncertainties in the marketplace," its share price tumbled 23% in one day.
And when Aurora Cannabis (ACB -1.95%) released disappointing first-quarter results back on Nov. 14, the stock was hammered in the days that followed -- down by 17% the next day, and another 16% the day after that. In two days, its share price went from $3.29 to $2.28, down a total of 31%.
Why should investors care?
Pot stocks are volatile, and some investors will point to the fact that while many of them have bad days, they also have very good ones as well, with double-digit price increases. But in many of these cases, one "bad day" is just the beginning (or a continuation) of a much larger decline. Today, Aurora's stock price struggles to stay above $0.70. The stock is down 92% in the past 12 months. It's performed even worse than the abysmal Horizons Marijuana Life Sciences ETF (HMLSF), which is down more than 70% in the same time.
Large movements in price, in just one or two days, are often signs that something's gone terribly wrong for a company. And when pessimism is high, the bears come out in full force, making the struggling stock a prime target for short sellers who hope to send it even lower. In Aurora's case, there's no telling where the bottom is -- the stock has continued to find ways to fall further and further down.
As attractive as some pot stocks may look today given their reduced valuations, all it takes is a scandal, a disappointing performance, or the suggestion that a company is running low on cash to send investors into a panic. So while the opportunities for long-term growth in the industry are promising, that doesn't mean it's safe to invest in cannabis stocks. The industry is constantly evolving, and companies that are here today may not be around years from now.
Investors who buy pot stocks need to accept the serious risks involved, including the possibility that they may incur significant losses. As the industry matures and companies become profitable, investing in cannabis will become safer. But for now, investors will want to keep a close eye on any cannabis companies that they hold in their portfolios, because there may be little, if any, warning if things go south.
