Many cannabis stocks went to pot last year. Shares of the four biggest Canadian cannabis producers ended 2021 in negative territory. So did the stocks of the four biggest U.S. cannabis operators.
The overall dismal performance could cause some investors to stay completely away from cannabis stocks. Others, though, might think there are some attractive opportunities to be found. Should you invest in cannabis stocks in 2022? Here's what you need to consider.
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Understand the challenges
Expectations for cannabis stocks were high (no pun intended) as 2021 began. Several U.S. states voted to legalize either medical or recreational cannabis in the November 2020 elections.
Democrats, generally more pro-cannabis than Republicans, claimed a solid majority in the U.S. House of Representatives. They also had a good chance at gaining control of the Senate by securing victories in two Georgia run-offs (and ultimately won both seats). The possibility of significant federal cannabis reform seemed realistic.
In both Canada and the U.S., investors hoped that new COVID-19 vaccines would help end the pandemic. This could rejuvenate a beaten-down retail industry -- including cannabis retailers.
As a result of all of this, cannabis stocks initially soared early last year. Canadian cannabis-producer Sundial Growers emerged as a meme stock and skyrocketed more than 500% by mid-February. But then it all fell apart. Why?
Investors began to realize that their expectations were too lofty across the board. Even with Democrats controlling both U.S. legislative chambers and the White House, federal cannabis reform didn't materialize.
Vaccines helped, but the pandemic didn't end, due to the spread of new coronavirus variants. The Canadian cannabis industry experienced significant supply/demand imbalances. The valuations of cannabis stocks seemed to have gotten ahead of the market realities.
The political dynamics of 2022 don't give much reason to be overly optimistic about near-term changes to federal cannabis laws. COVID-19 cases are hitting record highs in some areas. Unfortunately for investors, many of the challenges that caused cannabis stocks to slump last year are still present.
Evaluate the opportunities
There are still opportunities with cannabis stocks, though. Canadian cannabis producers such as Canopy Growth (CGC 1.28%) and Sundial Growers probably won't be able to jump into the U.S. marijuana market nearly as quickly as many anticipated. This restriction greatly limits the growth prospects for these Canadian pot stocks, at least over the near term.
However, the sell-off in 2021 has given some U.S. cannabis stocks especially attractive valuations. For example, Cresco Labs' (CRLBF -4.76%) shares trade at less than 2.5 times trailing-12-month sales. The company is already profitable and expects strong growth in 2022.
Another U.S. multi-state operator, Ayr Wellness (AYRW.F -5.67%), is even cheaper than Cresco. Ayr's shares trade below 2.4 times sales. Unlike Canopy Growth, Ayr currently generates positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). The company continues to see robust growth.
It's also important to note that some cannabis stocks delivered tremendous gains last year and still have solid prospects in 2022. Innovative Industrial Properties (IIPR 0.37%) has beaten the market for five consecutive years, with its shares soaring nearly 44% last year. All the company needs to do to keep up its winning ways is to find more cannabis properties to buy and lease them back to operators. That shouldn't be too difficult of a task for IIP to achieve.
To buy or not to buy?
Should you buy cannabis stocks in 2022? Yes and no.
The answer is a resounding "no" for risk-averse investors. Many of the challenges from last year haven't faded away, and most cannabis stocks remain highly risky.
I'd say that it's also a "no" when it comes to buying most Canadian cannabis stocks. My view is that the headwinds facing these stocks -- especially the inability to enter the U.S. marijuana market -- will continue to hamper their performance.
On the other hand, aggressive investors willing to take on a relatively high level of risk should be able to find bargains among U.S. cannabis stocks. I'd put Ayr and Cresco in that group. Long-term investors can also still win by buying strong ancillary stocks such as Innovative Industrial Properties.
There's no guarantee that 2022 will bring smooth sailing for cannabis stocks, in general. It probably won't. However, some cannabis stocks could be in a good position to navigate the still-treacherous waters.
