Global marijuana markets are growing like a weed. Worldwide spending on cannabis is on pace to top $29 billion in 2020, according to Statista. The total is projected to increase to $63.5 billion by 2024, for a compound annual growth rate (CAGR) of 21%. With this type of impressive growth, it's no wonder that many investors are interested in publicly traded cannabis stocks

What's the best approach to marijuana investing? There are seven key steps:

  1. Understand the types of marijuana products.
  2. Know the different types of marijuana stocks.
  3. Understand the risks of investing in marijuana stocks.
  4. Know what to look for in a marijuana stock.
  5. Evaluate the top marijuana stocks and exchange-traded funds (ETFs).
  6. Invest carefully.
  7. Monitor changing industry dynamics closely.

Here's all you need to know about this seven-step process for investing in the fast-growing marijuana industry.

A field of marijuana

Image source: Getty Images.

1. Understand the types of marijuana products

There are two broad categories of cannabis products:

  • Medical marijuana: Medical marijuana is broadly legal in 33 U.S. states plus the District of Columbia, and in over 30 countries. A prescription from an authorized healthcare provider is typically required for patients to obtain medical marijuana; it's frequently prescribed to adults for anxiety, depression, pain, and stress. 
  • Recreational marijuana: Eleven U.S. states plus D.C. have legalized recreational marijuana for adult use. Recreational marijuana has been legal in Canada since October 2018. 

2. Know the different types of marijuana stocks

There are also different types of marijuana stocks, and the three primary ones are:

  • Cannabis growers and retailers: These companies, which include Canopy Growth, cultivate cannabis (often in indoor facilities and greenhouses), harvest the crops, and distribute the end products to customers. Some also focus on operating retail stores for selling medical and/or recreational cannabis.
  • Cannabis-focused biotechs: These are biotechs (such as GW Pharmaceuticals) that develop cannabinoid drugs.
  • Providers of ancillary products and services: These companies support marijuana growers by providing products and services such as hydroponics products and lighting systems, a key area of focus for Scotts Miracle-Gro; packaging solutions; and management services.

3. Understand the risks of investing in marijuana stocks

Investing in any type of asset comes with some degree of risk. However, investing in marijuana stocks has specific risks you should understand.

  • Legal and political risks: Selling marijuana remains illegal at the federal level in the U.S. Even though cannabis businesses operate in states that have legalized marijuana for either medical or recreational purposes, the Department of Justice could clamp down at any time. In addition, U.S. federal law places severe restrictions on banks that deal with marijuana-related businesses. As a result, it's difficult for U.S. cannabis businesses to access critical financial services. Political support has increased for federally legalizing marijuana, but there's no guarantee it will happen.
  • Supply/demand imbalances: Canadian marijuana growers initially undertook major expansion initiatives to increase production capacity to meet recreational marijuana demand. However, some companies have now cut back production. When supply outstrips demand, prices usually fall. In this scenario, marijuana growers could find their revenue and earnings decreasing, which would hurt their stock prices.
  • Over-the-counter (OTC) stock risks: OTC stocks don't have to file regular financial statements, which are important for investors, enabling them to assess the risk of the stocks. They also don't have to maintain minimum market caps (the total value of outstanding shares), which can result in a low level of liquidity (how easily the stock can be bought or sold without its price being affected).
  • Financial constraints: Many cannabis companies are unprofitable and face the prospect of running out of cash. They often have to raise capital by issuing new shares, which dilutes the value of existing shares. Even with this option, obtaining enough capital to fund growth can be challenging.

4. Know what to look for in a marijuana stock

When considering any marijuana stock to invest in, you should:

  • Research the management team
  • Examine the company's growth strategy and competitive position
  • Check out the company's financials
  • Research how many warrants and convertible securities the company has issued (a high number could mean that the stock will be diluted in the future, potentially causing the share price to drop)

Specific metrics to research for marijuana growers include:

  • All-in cost of sales per gram: Includes all costs of producing cannabis.
  • Cash cost per gram: Includes all costs of producing cannabis except amortization, packaging costs, and inventory adjustments.

Marijuana growers with lower cost structures will tend to be more competitive.

5. Evaluate the top marijuana stocks and ETFs

Now for the fun part: digging into the top marijuana stocks. You might also want to check out marijuana-focused exchange-traded funds (ETFs).

Below is a list of top marijuana stocks and ETFs to consider. Note that this list isn't comprehensive, and includes only marijuana stocks with a market cap of at least $200 million.

Type

Company

Market Cap

Cannabis growers and retailers

Canopy Growth Corporation (NASDAQ:CGC) $6.2 billion
Cronos Group (NASDAQ:CRON) $2.3 billion
Green Thumb Industries (OTC:GTBIF) $1.9 billion
Aurora Cannabis (NYSE:ACB) $1.5 billion
Aphria (NASDAQ:APHA) $1.2 billion
Tilray (NASDAQ:TLRY) $1.1 billion
Cresco Labs (OTC:CRLBF) $876 million
Charlotte's Web (OTC:CWBHF) $666 million
HEXO (NYSE:HEXO) (TSX:HEXO) $410 million
OrganiGram (NASDAQ:OGI) $350 million

Biotechs

GW Pharmaceuticals (NASDAQ:GWPH) $3.9 billion
Cara Therapeutics (NASDAQ:CARA) $719 million
Corbus Pharmaceuticals (NASDAQ:CRBP) $510 million

Ancillary providers

Scotts Miracle-Gro (NYSE:SMG) $7.5 billion
Valens (OTC:VLNCF) $279 million

ETFs

ETFMG Alternative Harvest ETF (NYSEMKT:MJ) $581 million*
Horizons Marijuana Life Sciences ETF (OTC:HMLSF) $388 million*

*Reflects net assets. All data as of June 12, 2020. Data source: Yahoo! Finance.

6. Invest carefully

What exactly does it mean to "invest carefully" in marijuana stocks? For some, particularly conservative investors, the best approach will be to avoid them entirely. Only the most aggressive investors who can tolerate high levels of risk should jump in.

Even aggressive investors should buy in only after completing the five previous steps. Marijuana stocks are both risky and highly volatile; putting too much of your investment portfolio into any marijuana stock or ETF isn't wise.

Consider starting off with a small position in a marijuana stock. As the cannabis market grows and a company's increasing revenue and earnings confirm your investment thesis, you can add more shares. If the growth you were counting on doesn't materialize, you should reevaluate your assumptions.

Also, some marijuana stocks are arguably safer than others. For example, Scotts Miracle-Gro makes most of its revenue outside of the cannabis industry. The company historically sells lawn and garden products, and that market doesn't face many of the risks associated with cannabis products. Less aggressive investors might prefer a stock like Scotts to a more pure-play marijuana stock like Canopy Growth.

7. Monitor changing industry dynamics closely

Generally speaking, investors are better off taking a long-term view when buying stocks. That being said, the dynamics of the marijuana industry are rapidly changing. The criteria you should use to make a buying decision could be dramatically different just a few months down the road.

Because of this, I recommend that you monitor any marijuana stocks or ETFs that you buy, along with the overall industry itself, very closely and frequently. Some changes could be beneficial -- for example, potential relaxation of U.S. federal marijuana laws. Other changes, however, could be bad news, such as the possibility that European medical cannabis markets won't grow as quickly as expected.

Tremendous growth should be in store for the global marijuana industry, but it might not come as evenly as you'd prefer. Following these seven steps can help you navigate this exciting and challenging investing opportunity.