Are Marijuana Stocks a Buzz Kill for Investors?
It seems as though every decade or so a new investment phenomenon comes along with the power to drive investors into a frenzy. As history shows, such frenzies can lead to bubbles, and when bubbles pop, they can cause mass financial devastation.
You may recall the dot.com bubble of the late 1990s when market valuations evaporated overnight. Then there was the catastrophic housing bubble in the late 2000’s that sliced home prices in half. More recently, we’ve seen the collapse of Bitcoin and other cryptocurrencies after a meteoric rise in prices.
The common thread running through all these events was the sky high and unsustainable valuations of the underlying assets. And, out of greed, or fear of missing out, investors could not overcome the temptation to make a quick buck. Bubbles tend to burst when investors can no longer figure out how much an asset should be worth, so they stop investing. When sellers can’t find any more buyers, they flee the market, sending prices into a freefall.
The question today is whether we may be witnessing yet another potential bubble with the latest investment phenomenon – marijuana stocks. While it may be too soon to tell, investors in this new and fast-growing sector are showing clear signs of unbridled exuberance, which is one step away from frenzy. Let’s take a look at the market today and why investors should proceed with caution.
With its decision to legalize recreational marijuana use in October, Canada has become the epicenter of the marijuana industry. Right now, there are 144 cannabis companies listed in Canada with a total market value of about $41 billion (USD). However, 20 percent of that market value, about $8 billion, is concentrated in the 10 biggest companies, which are all now based in the U.S. By 2022, global marijuana sales outside of the U.S. are expected to reach $8.6 billion. If you add in the U.S. market, sales could reach $32 billion.
Here’s the problem: Marijuana is still illegal in the U.S. under federal law. While there is growing sentiment among the public and politicians in favor of legalizing marijuana – 9 states have legalized recreational marijuana use and 29 states have legalized it for medicinal purposes – it is not likely to win approval anytime soon.
Yet, a few of the larger marijuana stocks are trading at atmospheric levels, at valuations way beyond their capacity to generate earnings. The largest publicly traded stock is Tilray, which went public in July of 2018. Within two and half months, spurred on by the passage of marijuana legalization in Canada, the stock skyrocketed more than 1000%, making the company worth more than American Airlines, though it generates zero profits.
Although the share price has fallen off in recent weeks, its lack of profits does not justify its high valuation. Other major cannabis stocks, such as Canopy Growth, Aphria and Cronos Group also experienced sharp increases followed by steep declines. None of these companies have yet to show a profit and, due to uncertainty of the U.S. market, no one can project when or if they will.
Like the dot coms of two decades ago, the cannabis industry is a market in search of itself. But investors couldn’t get enough of the dot coms, regardless of whether they were expected to generate a profit. We all know how that turned out. As in the past, investors are looking past the fundamentals and economic realities of a fledgling industry in hopes of scoring the next Amazon – one of the few companies to rise from the dot com rubble. But, as many of the dot com investors will tell you, “Hope is not a strategy.”