As bad as the stock market has been doing of late, cannabis stocks have been even much worse buys. As of Sept. 26, the Horizons Marijuana Life Sciences ETF's price is down 61% over the trailing 12 months, versus the S&P 500's more modest decline of 18%. Buying on the dip is a tricky prospect for cannabis investors because pot stocks have continually gone in one direction: down.
One catalyst that could turn things around is the legalization of marijuana in the U.S. But even though more people are using pot than in the past, that still doesn't mean legalization is around the corner. So it boils down to an all-important question: Should you buy cannabis stocks today, or are you better off waiting?
Why you might not want to wait
The case for investing in cannabis stocks today centers around the industry's long-term growth potential. Analysts from Allied Market Research expect that globally, the cannabis market will grow at a compound annual rate of more than 20% until 2031, when it will be worth nearly $149 billion.
There will be significant opportunities for businesses to expand and grow their market share in the U.S. and worldwide. While investors shouldn't get their hopes up for federal legalization in the U.S. anytime soon, that doesn't mean more states won't open up for business. New Jersey and New York are among the most recent states to pass legislation permitting adult-use pot.
Internationally, Germany might become the largest country to allow cannabis since it is also considering legalization as early as next year. Meanwhile, in Australia, a political party, the Greens, is also working on a campaign to legalize marijuana.
A stock like Aurora Cannabis (ACB 18.15%) which has a presence in 25 countries, could be a big winner, benefiting from loosening pot laws around the globe. Trading below book value and a price-to-sales multiple of less than two (the average cannabis stock on the Horizons Marijuana Life Sciences ETF trades at close to five times revenue), it's a discounted growth stock that could have some promising potential in the long term.
However, suppose you wait until there's better newsflow around the federal legalization of pot, leading to more bullishness on the cannabis industry. In that case, you'd likely buy Aurora Cannabis and other pot stocks at much higher prices than where they are today.
Why you should consider waiting
The big danger with pot stocks is that many, such as Aurora, are incredibly risky. In Aurora's case, the stock might look cheap, but that's also because it has continually disappointed investors. Moreover, promises of getting to profitability have been a work in progress that never appears to be complete.
Aurora just released its year-end results for the period ending June 30, and its adjusted loss based on earnings before interest, taxes, depreciation, and amortization (EBITDA) was more than 51 million Canadian dollars ($37.5 million). Although that was down from a loss of CA$118 million in the previous fiscal year, it demonstrates how far the company still has to go just to achieve an adjusted profit number.
Even for U.S.-based cannabis businesses that post adjusted EBITDA profits, they still aren't truly profitable as net losses are the norm for the industry:
Data by YCharts.
The danger for investors is that while waiting for legalization in the U.S., some businesses might simply not be around for it. And even if they don't end up going out of business, the landscape could change, new businesses might enter the industry, and companies may not be as dominant as they appear to be today. That could result in you incurring even larger losses along the way.
By waiting to see what the industry looks like, investors can make better, safer decisions as to how to invest in cannabis stocks.
It all comes down to your risk tolerance
If you're comfortable with taking on significant risk and are OK with waiting many years for legalization, then buying cannabis stocks today could eventually prove to be profitable. However, I still wouldn't suggest investing in a struggling stock like Aurora Cannabis -- multi-state operators in the U.S. have far superior financials than their Canadian counterparts and are more attractive buys.
But even those stocks could continue to struggle, and if you're not comfortable with a high level of risk, then waiting for legalization might be the best option for you.
