The stock market has been off to a great start to 2024, with the S&P 500 hitting the 5,000 mark for the first time ever. While big tech is a key reason for the index's success, investors shouldn't overlook another hot area of the stock market, and that's cannabis.
Pot stocks have been surging in value this year as investors have warmed up to growth stocks as a whole amid hopes that interest rates will come down. Lower interest rates will lessen borrowing costs and thus decrease the overall risk for growth stocks and businesses that aren't yet profitable.
The AdvisorShares Pure US Cannabis ETF (MSOS 4.28%), which invests in multistate marijuana companies, has soared nearly 40% since the start of 2024, and that's after giving back some gains in recent trading days. Is this a sign that optimism has returned to the cannabis industry and that it's a good time to invest in pot stocks again?
Low valuations have made pot stocks more attractive
The AdvisorShares Pure US Cannabis exchange-traded fund is actively managed and holds swaps, which are financial derivatives, of many multistate marijuana companies, including big names such as Green Thumb Industries, Curaleaf Holdings, and Trulieve Cannabis. While these are top cannabis producers in the U.S. market, they haven't exactly been great investments. Over the past three years, their valuations have all declined by more than 60%.
Their respective price-to-sales multiples have also come down significantly.
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Regardless of whether you expect marijuana legalization in the U.S. to happen in the near future, distant future, or never, there's still the expectation that there is a lot of growth in the global pot market. Researchers at Fortune Business Insights projected last year that the global cannabis industry will grow at a compound annual growth rate of more than 34% until 2030.
That long-term potential could entice investors to take a chance on some of these stocks, especially as other growth stocks may have become overvalued of late.
Why cannabis investors might be feeling a bit more bullish these days
Although some pot stocks have been hot out of the gate (Trulieve, in particular, was up around 90% at the start of 2024), a big part of the reason is speculation, and hopes that marijuana reform could be on the horizon.
The Drug Enforcement Administration (DEA) is reportedly considering rescheduling cannabis so that it does not share the same Schedule I classification as other dangerous substances such as heroin and ecstasy. But even if it is changed to a lower classification, that alone doesn't mean that legalization of cannabis will follow.
There is also the hope that in November, Florida will have the opportunity to vote on legalizing marijuana for recreational use (it's already approved for medical reasons). Trulieve has a huge presence in Florida (131 locations), which is why many investors may be feeling bullish on its prospects, as it would arguably stand to benefit the most from the launch of a recreational pot market in its home state.
The danger for investors is that neither of these developments is guaranteed to happen. The DEA may opt not to reschedule cannabis, and Florida may not end up legalizing marijuana for recreational use. Cannabis investors have been here before, with high hopes for marijuana reform often dashed later on. Odds, however, are high that Florida will legalize recreational marijuana before the federal government makes a big move; 24 states and the District of Colombia have already legalized marijuana for recreational use.
Is now the time to invest in cannabis stocks?
Pot stocks haven't made great investments in recent years. But there is undoubtedly a lot of growth potential in the industry. If you're willing to take on the risk and uncertainty and hang on for the long haul, there could be an opportunity to generate some promising gains from pot stocks, given how low-priced many of them still are today.
Investing in a fund such as the AdvisorShares Pure US Cannabis ETF can be a good way for investors to gain exposure to the U.S. cannabis market, as it holds shares of the best cannabis stocks in the country. And since the fund is actively managed, you likely won't have to worry about tracking new pot stocks or opportunities which come up in the industry.
The caveat, however, is that investors should be careful not to assume that the current rally will last or that significant reform at the federal level will take place in the near future. Investors often get burned by setting their expectations too high. If, however, you go into this knowing that there can and likely will be significant volatility and that it may be several years before there is a big payoff, then investing in the AdvisorShares Pure US Cannabis ETF could prove to be a smart move.
