Here's When I See Cannabis Stocks Being Hot Buys Again

The bear market has been pummeling stocks for much of the past year. But in the cannabis industry, investors have been dealing with falling valuations for much longer than that. Since 2021, shares of Tilray Brands (TLRY) and Canopy Growth (CGC 20.65%) are down 70% and 92%, respectively. These aren't just dips; they are all-out crashes. And these declines are common in the industry as there simply hasn't been a reason to invest in pot stocks of late. Here's what I think needs to happen for these stocks to be hot buys again.

When there's hope for marijuana legalization, there are often soaring pot stocks

One thing that can and often does get investors bullish about pot stocks is when there's the hope that legalization in the U.S. might be on the horizon. A classic example of that is what happened when Joe Biden was elected president in 2020 and there was optimism in the industry that with a Democrat in power, it might lead to some progress on marijuana reform. Between November 2020 and February 2021, shares of Tilray and Canopy Growth more than doubled in value.

Those stocks have given back those gains since then. And pot stocks will not likely be hot buys again until there's a similar catalyst that gets cannabis investors excited. There was some noise late last year about marijuana legalization and guess when that happened -- just before the midterm elections. Although that failed to deliver much of a boost for pot stocks, you can start to see the role that politics can play in determining just how much excitement there is around the industry, which, in turn, determines the level of bullishness behind pot stocks.

That's why I would expect the summer or early fall of 2024, before next year's election, to be when there could be a lot of talk about marijuana legalization again. Legalization has the potential to add jobs to an economy that by then could be struggling and in need of a boost. Plus, one way to rally voters could be to use marijuana legalization as an election promise (that's how Canada eventually legalized marijuana -- Prime Minister Justin Trudeau made that part of his platform).

There's a lot that will happen by the time the next election day comes around, but I'm confident that marijuana will again be a hot topic by then. And regardless of whether legalization takes place, at the very least, the election's approach could drum up some excitement in the industry and lift pot stocks higher -- even if it proves to be another temporary boost.

Will legalization really change things for the better?

Legalization talk does often get investors excited about pot stocks, but would legalizing the industry actually make things better for businesses? There would be some clear wins -- multi-state operators could have products cross state lines, they would easily be able to do business with big banks, and it would open up the possibility of partnering with businesses in other industries (e.g., tobacco and alcohol).

But on the flip side, there are all sorts of red tape that comes along with government legislation. All you have to do is look at Tilray and Canopy Growth as examples. These are two Canadian-based cannabis companies that are struggling to generate growth and are consistently burning through cash and incurring losses. They are eager to enter the U.S. market for the potential growth that it offers. But once legalization hits, cannabis companies would face more taxes, more legislation, and more potential competition.

Legalization should make things better for cannabis companies, but whether it will be enough to make these businesses good investments is debatable and isn't clear just yet.

Should investors wait until next year before buying pot stocks?

Pot stocks could get hot next year if talk of marijuana legalization picks up, but that doesn't mean investors should buy them then. This pattern has gone on many times in the past few years where there's a new bill that talks about legalizing pot that leads to a jump in share price, and then when nothing happens, the stocks inevitably give back those gains.

A sounder strategy is to not focus on the hype and noise and instead to look at a company's results and financials. Without positive cash flow and profitability, dilution and poor stock returns may be inevitable for cannabis investors. Even if legalization does happen, investors shouldn't assume that will fix a company's problems.

For most investors, even next year might be too early to invest in the cannabis industry. Unless you have a high risk tolerance, you're better off simply steering clear of cannabis companies until they have much stronger financials -- regardless of how much hope there is about marijuana legalization.