So the cannabis craze is sweeping the nation and you are hoping to take advantage.
With new opportunities arising every day, it appears that things are looking up for the once-condemned market, and you are looking to find the best marijuana penny stocks to invest in.
But with so many opportunities, how do you know which one to pick?
Well, to begin, let’s determine whether you should invest in marijuana stocks.
Then, we will outline what to look for when investing in cannabis companies.
Lastly, this article will provide you with a few of the hottest marijuana stocks and cannabis ETFs to add to your watchlist.
Are Cannabis Penny Stocks a Good Investment?
At a macro level, investing in marijuana stocks looks like a wonderful opportunity, given the many economic and regulatory tailwinds within the industry.
However, to truly understand whether cannabis stocks are a good investment, we must zoom in and analyze the businesses themselves to determine what makes a great marijuana stock investment.
But first, a quick glimpse into the industry at large.
The Cannabis Industry at a Glance
The cannabis industry is experiencing an incredible upswing due to widespread adoption and deregulation in the American market.
With many investors looking to take advantage of these positive trends, here are a few numbers and forecasts to help facilitate your decision.
As of 2021, the US marijuana market was valued at $10.8 billion and is expected to grow at a compound annual growth rate (CAGR) of 14.9%, reaching $40 billion in 2030, according to Grand View Research.
With improved regulations across the nation, the use of medical cannabis products is now permitted in 37 states, while the recreational use of weed is either legal or decriminalized in 32 states, according to THCaffiliates.com.
In addition, 91% of adults approve of the legalization of marijuana, with 49% of them saying they have consumed cannabis at least once in their lifetime (flowhub); this is up from 40% just 7 years ago.
So, with all of this pumped-up demand, is it worth investing in marijuana stocks, and will these trends last?
Well to answer these questions, let’s explore a maturing marijuana market to better understand how its experience thus far might shed light on what is to come.
Is Investing in Cannabis Penny Stocks Risky?
With the Cannabis Act coming into effect on October 17, 2018, Canada became one of the first countries in the world to federally legalize the recreational use of cannabis.
In doing so, it opened the floodgates for investments and business opportunities as Canadians hoped to capitalize on the surge in demand.
By pouring billions of dollars into these companies, investors expected their marijuana stocks to perform extraordinarily well as they rode the wave to profitability.
Instead, something much worse occurred.
To be blunt, the private sector, including publicly traded companies, has performed poorly since its legalization in 2018.
While government-owned entities like the Ontario Cannabis Store (OCS) and Société Québécoise du Cannabis (SQDC) have turned a profit, the private marijuana sector has been dismal.
It has accumulated losses easily exceeding CA$16 billion, according to MJBizDaily, while OCS earned roughly CA$262.8 million in three years (ended March 2022), and SQDC has earned CA$168.5 million since 2018.
To emphasize this point, here are the five largest Canadian marijuana companies, by market cap, and their respective losses.
Top 5 Canadian Marijuana Stocks (by market cap)
As of 2022, these are the top five Canadian marijuana stocks based on their market cap:
Tilray Brands Inc ($TLRY)
- Market Cap: $1.40 billion
- 1-Year Returns: -49.74%
- Net Income (US$ in thousands): -12,194 (2019); -61,016 (2020); -367,421 (2021); -476,801 (2022); -1,443,000 (2023)
Canopy Growth ($CGC)
- Market Cap: $649.87 million
- 1-Year Returns: -81.74%
- Net Income (CA$ in thousands): -685,438 (2019); -1,321,326 (2020); -1,744,920 (2021); -302,181 (2022); -3,278,158 (2023)
Cronos Group ($CRON)
- Market Cap: $967.96 million
- 1-Year Returns: -39.52%
- Net Income (US$ in thousands): -13,928 (2018); 1,166,506 (2019); -73,137 (2020); -396,107 (2021), -168,734 (2022); -143,404 (TTM)
- Market Cap: $774.58 million
- 1-Year Returns: +3.27%
- Net Income (US$ in thousands): -16,173 (2018); -165,194 (2019); -121,650 (2020); 3,111 (2021); -303,959 (2022); -341,393 (TTM)
Aurora Cannabis ($ACB)
- Market Cap: $288.11 million
- 1-Year Returns: -64.74%
- Net Income (CA$ in thousands): -290,837 (2019); -3,283,671 (2020); -693,625 (2021); -1,717,624 (2022); -1,747,960 (TTM)
Are Cannabis Stocks Risky?
Marijuana stocks are off to a difficult start, but that doesn’t mean that they are doomed forever.
The reality is that cannabis stocks, especially marijuana penny stocks, face considerable challenges when it comes to creating a competitive advantage.
Here are the top three reasons why cannabis stocks are risky:
1. Why Cannabis Stocks are Risky: Strict Government Regulations
While the environment for consuming cannabis products has improved tremendously, the same can’t be said for businesses hoping to take advantage of the growing demand.
With the legalization of cannabis, the Canadian government created multiple laws under the Cannabis Act to protect consumers from harmful products and substance abuse.
Although necessary, these laws have prevented marijuana companies from maximizing their potential since they must comply if they wish to operate within the industry.
For example, the Canadian cannabis industry faces heavy taxation on licensed cannabis producers (LPs); for every gram of cannabis sold, LPs pay the federal government $1.
Furthermore, upon legalization in 2018, provincial governments were granted jurisdiction over all means of distribution, essentially making them monopolies within their designated region.
According to Alison Gordon, former CEO and Founder of 48North Cannabis Corp:
“On average, provincial distributors take a markup of 35% to 45% on products, even though they do not engage in many of the traditional functions of a distributor, such as helping to secure shelf space in retail outlets.”
With laws like these, it is quite difficult to generate profits when a cannabis company is forced to follow these stringent rules.
Unfortunately, these laws are unlikely to improve, given the nature of the products, which means that regulatory challenges are likely to persist for the foreseeable future.
For more information on the possible risks associated with marijuana stocks and the government, check out the full article by Alison Gordon here.
2. Why Cannabis Stocks are Risky: Cannabis is a Commodity
Possibly the greatest challenge facing cannabis companies today is that they operate in a market where their product is a commodity.
As such, consumers pay less attention to the brand they are buying from and instead focus primarily on how much they will end up paying.
Under these circumstances, marijuana companies are forced to compete on price alone, which leads to a deflationary spiral like the one seen above.
For this reason, it is very difficult for a marijuana company to form a competitive advantage unless it can establish itself as a low-cost producer within the industry.
To do so, a cannabis company must scale quickly and reduce operational inefficiencies like production time and distribution costs wherever it is possible.
As demonstrated by the government-owned entities mentioned earlier, these publicly-owned businesses are at an incredible advantage, given that they have the backing of the people in charge.
For a private business to achieve similar success, it must be able to cut costs as effectively as its public competitors, while still operating within the current regulatory environment.
However, due to the existing laws in place, it is unlikely that cannabis stocks will succeed, unless these restrictions ease in the near future.
Unfortunately, this means that as a cannabis investor, it is most likely that pot stocks underperform the broader market until a competitive advantage is more attainable.
3. Why Cannabis Stocks are Risky: The Cannabis Industry is Young
When you think about it, the marijuana sector is quite young compared to most industries in the stock market today.
Therefore, it is quite difficult for investors to know how marijuana penny stocks will perform during tough market conditions, given that they have yet to experience a real economic recession.
Sure, the cannabis industry did endure the pandemic crash, but the effects of that bear market were short-lived as the US Federal Reserve and other central banks around the globe printed money at an unprecedented rate.
To truly understand how resilient a company is, the business must first face the brutalities brought on by a major economic recession and prove that they can overcome the financial hardships headed their way.
If they can do so successfully and remain profitable throughout the economic storm, it is a testament to their resiliency and a strong vote of confidence from investors.
As Warren Buffet would say:
“A rising tide floats all boats, but only when the tide goes out do you discover who’s been swimming naked.”
How to Evaluate Cannabis Penny Stocks
Like with any stock we explore, we recommend following the Edge Investments investing strategy for evaluating individual stocks.
Based on what we have already said about marijuana penny stocks, it is strongly suggested that you follow these rules for the best chance of success when investing in penny pot stocks.
Step 1: Do you understand the business?
Being able to understand a business and how it operates is one of the most important aspects when it comes to investing in individual stocks.
For example, If you are either a consumer of cannabis or an employee at a marijuana company, then you are likely to have a better understanding of the cannabis industry than most investors.
On the other hand, if you do not use marijuana yourself, it may be best that you avoid investing in pot penny stocks altogether given that you aren’t familiar with any of the companies or the products they sell.
To shed more light on the industry, marijuana stocks operate within three distinct markets, according to the Motley Fool:
- Marijuana growers and retailers who sell to end-consumers.
- Biotech companies develop cannabis-based pharmaceutical drugs.
- Ancillary cannabis companies sell products and services without touching the plant.
When analyzing marijuana penny stocks, determine which of these markets you understand best and attempt to learn more about how companies within that segment create value.
If you believe that you are capable of determining which stocks are likely to be the strongest within their respective market, then this is a positive sign that you might be well suited for investing in the cannabis industry.
As a general rule of thumb in investing, the more you know about a business and its industry, the better.
Step 2: What is the pot stock’s competitive advantage?
As we mentioned earlier, it is very difficult to achieve a competitive advantage in the cannabis industry given the many economic challenges that exist in the market today.
However, if you do find a marijuana penny stock with a competitive advantage, then it is recommended that you spend most of your time analyzing that business because it is most likely to be the best investment opportunity available.
When searching for marijuana penny stocks with a competitive advantage, the easiest way to do so is to find pot stocks that are consistently profitable, growing revenues year over year, and maintaining their profit margins as well.
After going through the numbers and confirming that a competitive advantage exists, take some time to consider what risks might pose the biggest threat to the business and if it is likely for a competitor to accomplish this.
If you determine that it is unlikely anyone will destroy the business’s MOAT, then that penny stock is your best bet for generating superior investment returns.
By investing in pot stocks like these, you will set yourself up for success because they are the most capable of surviving an economic downturn and outlasting the competition.
However, if you are unable to find such a business, then it may be best to sit patiently until such an opportunity arises.
Step 3: Who is the management team?
Given how young the pot industry is, it is important to find a marijuana penny stock that possesses a management team with extraordinary qualities.
Due to the current market conditions, it is important to invest in companies with managers that are aware of the challenges that exist and are comfortable sharing these risks with investors.
When a management team is open and honest while also offering solutions to the issues it is a positive sign that they are properly aligned with investors.
Since most of us are unable to speak directly with the management teams, the best way for us to retrieve this information is through the company’s annual reports and quarterly earnings calls.
In addition, you may also evaluate how much the CEO has invested in the company and their ability to allocate capital effectively (as per the ROIC metric); the bigger these numbers are, the better.
Step 4: What is the business worth?
The final step before investing in penny pot stocks is to figure out how much the business is worth.
Since most of these marijuana penny stocks are not cash flow positive yet, our next best option is to compare them to other businesses within the same industry.
When comparing companies, check out their financial ratios like P/BV, P/S, EV/EBITDA, and P/E (if they are profitable).
Whoever has the lowest number of financial ratios across the board is most likely to be the most undervalued business within the industry.
Ideally, you want to wait for the opportunity to invest in the best marijuana penny stock when it is trading at a discount relative to their industry peers.
For more information on how to successfully invest in penny stocks, check out our full “Penny Stock Investing Beginners guide”.
Top 5 Cannabis Penny Stocks to Watch
While we highly recommend exercising caution and due diligence when investing in cannabis penny stocks, ultimately it is your decision whether you invest in them or not.
Therefore, it is valuable to know what marijuana stocks are available on the market because you never know which business might change the industry for the better.
As such here are five penny pot stocks to watch out for:
- Market Cap: $301.904 million
- 1-Yr Returns: -63.46%
- Revenues TTM: $314.289 million
- Market Cap: $57.094 million
- 1-Yr Returns: -88.70%
- Revenues TTM: $176.686 million
High Tide ($HITI)
- Market Cap: $105.056 million
- 1-Yr Returns: -63.73%
- Revenues TTM: $302.471 million
Sundial Growers ($SNDL)
- Market Cap: $510.94 million
- 1-Yr Returns: -64.16%
- Revenues TTM: $494.511 million
Medical Marijuana ($MJNA)
- Market Cap: $55.887 million
- 1-Yr Returns: -53.50%
- Revenues TTM: $33.445 million
Should I Buy Marijuana Penny Stocks?
So now that you have heard our thesis on whether or not to invest in penny pot stocks, should you buy a few shares?
Well, it’s clear that there are many risks involved when investing in this market, but with the right strategy, there may be wonderful opportunities to invest in cannabis companies.
If you believe that you have an informational advantage compared to most investors (ie. you are an employee at a cannabis shop), then this may be your best bet at investing in this industry.
Otherwise, we suggest that you focus a lot of time and effort trying to determine a marijuana penny stock that has a competitive advantage and is trading at a reasonable valuation relative to its worth.
However, if you do not have the time to commit to this research, but are still interested in investing in the marijuana market, then your next best bet is to check out a cannabis ETF like the ETFMG alternative harvest ETF ($MJ) or Cambria Cannabis ETF ($TOKE).
That way you still have exposure to the marijuana market without having to commit endless hours to find the top marijuana penny stocks to invest in.
All-in-all, the cannabis industry is still very young and a lot is unknown about where it is headed in the near future.
For those investors with a long investment horizon, stay patient, and watch out for new opportunities to arise in the cannabis market.
If you take the time to understand this industry and others and wait for opportunities when wonderful businesses are trading at a discount to their value, then you will set yourself up for success no matter what industry you choose to invest in.
Rational investing will always protect you regardless of what kind of investment environment you are in.
We are not brokers, investment or financial advisers, and you should not rely on the information herein as investment advice. If you are seeking personalized investment advice, please contact a qualified and registered broker, investment adviser or financial adviser. You should not make any investment decisions based on our communications. Our stock profiles are intended to highlight certain companies for YOUR further investigation; they are NOT recommendations. The securities issued by the companies we profile should be considered high risk and, if you do invest, you may lose your entire investment. Please do your own research before investing, including reading the companies’ public filings, press releases, and risk disclosures. Information contained in this profile was provided by the company, and extracted from public filings, company websites, and other publicly available sources. We believe the sources and information are accurate and reliable but we cannot guarantee it. The commentary and opinions in this article are our own, so please do your own research.
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