When it comes to hot investing opportunities, few are likely to raise the eyebrows of traders these days more than marijuana.
Estimates as to how big the legal marijuana market could eventually become vary wildly. According to Greenwave Advisors, which released an extensive report a few weeks ago on the projected value of the marijuana market if the federal government legalized the drug, legal marijuana could be worth a whopping $35 billion. Even if the federal government doesn't legalize marijuana, which seems like a more likely scenario considering the government's current stance, Greenwave still projects that the marijuana market would be worth $21 billion. This figure is derived from Greenwave's expectation that 37 states will have approved medical marijuana and an additional 12 states will have approved recreational adult-use marijuana by 2020.
Marijuana stocks soar
As you might imagine, the potential for exponential growth in both legal and medical marijuana sales as the public's perception of marijuana continues to improve is providing the impetus that's pushed nearly all marijuana and marijuana-related stocks higher.
For instance, GW Pharmaceuticals (NASDAQ:GWPH), which has discovered five dozen cannabinoids derived from the cannabis plant, and Insys Therapeutics (NASDAQ:INSY), which is developing a quicker-acting synthetic THC-based treatment to fight chemotherapy-induced nausea and vomiting known as dronabinol, have risen roughly 650% and 135% respectively over the past 15 months.
Both GW Pharmaceuticals and Insys represent the most viable medical marijuana investment opportunities, not only because of their larger market valuations, but also because they're long-established companies with modestly deep drug development pipelines. Insys, for example, has two Food and Drug Administration-approved products as well as dronabinol currently under review. GW Pharmaceuticals, on the other hand, has one approved drug (Sativex) in more than a dozen ex-U.S. countries, and another eight clinical studies under way.
I fully admit to being a bit skeptical of both GW Pharmaceuticals and Insys considering the premium being assigned to both companies by what I believe are emotional traders. Sativex hasn't sold very well for GW Pharmaceuticals, and it could be years before the company turns profitable. Insys is at least profitable, but at 34 times earnings I have to wonder if there's any upside left in its shares.
Why marijuana is a dangerous investment
But in the grand scheme of things I view GW Pharma and Insys as considerably better investment options than the roughly 20 other marijuana and marijuana-related stocks that traders can buy on the pink sheets.
After receiving a steady stream of comments in previous columns, tweets, and personal emails that wondered why I didn't research and/or write about a certain marijuana stock not named GW Pharmaceuticals or Insys, I decided to do some digging into these pink sheet marijuana penny stocks, and came to one conclusion: they're extremely dangerous. In fact, these penny stocks are the sole reason why I believe marijuana is the most dangerous investment opportunity in the entire market.
First, the standard penny stock rules, regardless of industry, apply here. Companies that are listed on the pink sheets aren't required to follow the same stringent reporting schedule that NYSE or Nasdaq-listed stocks have to follow. This means pink sheet-listed companies can simply choose not to report their earnings very often, if ever. In fact, getting basic information like remaining cash on hand, assets, debts, and profitability could prove practically impossible.
Yet, marijuana penny stocks introduce a new dynamic: many are just piggybacking on the hype surrounding marijuana regardless of whether or not they have any industry expertise.
Take CannaVEST as a good example. Today the company "distributes hemp-based consumer products to the nutriceutical industry," at least according to Yahoo! Finance's description of the company. However, CannaVEST only changed its name in Jan. 2013, following a reverse merger and soon after Washington state and Colorado had passed their recreational marijuana laws, from Foreclosure Solutions, a mortgage solutions lending company. In other words, with the housing market no longer offering incredible growth prospects, this company completely switched gears and suddenly has the "expertise" to sell hemp-based products.
Want more? How about Cannabis Therapy Corp. and its $21 million market valuation. The company nowadays sells pharmaceutical grade products containing phytocannabinoids, but switched its name and business model earlier this year. Prior to being a pharmaceutical company, Cannabis Therapy was known as Frac Water Systems, a water solution management company for the U.S. oil and gas industry. Let's just say I highly doubt this has been a seamless business transition.
Even larger companies, like the $115 million Cannabis Sativa, have garnered quite a few investors, but have little of anything tangible to show. Following a reverse merger earlier this year that had previously seen the company pitching a line of cosmetic products, Cannabis Sativa's business now focuses on its want to enter all facets of marijuana marketing and distribution under its "Hi" brand name. This company plan was put into motion just five weeks ago, yet it has generated practically no revenue (just $227 last quarter) thus far and its latest quarterly report carried this warning:
"There have been significant changes in our business and financial condition as a result of the Reorganization with Wild Earth Naturals and our acquisition of Kush. We anticipate that we will require significant additional debt or equity capital in order to continue our operations and implement our business plan. We have not entered into any agreement or arrangement for the provision of such financing and no assurances can be given that such financing will be available to us on acceptable terms or at all."
Honestly, the list goes on, but in an effort to not turn this into a manifesto I'm going to stop there.
Why I won't buy a marijuana stock
So why don't I discuss marijuana penny stock? On top of the fact that we at The Motley Fool have market-limit thresholds that we adhere to ($200 million market value and higher) when discussing stocks so as not to influence their movement, the majority of these companies are very problematic. Most seem to have unfounded or questionable business models, sorely lack proper financing, and they're working in an industry that's still in the process of evolving. It's emotional investing at its finest, but it's also extremely dangerous.
My suggestion to you is to stick to the sidelines, perhaps add GW Pharmaceuticals and Insys to your watchlist, and avoid the temptation of marijuana penny stocks at all costs.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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