Gambling on Pot Stocks - Are They Worth the Risk?

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It's somewhat alarming when a friend, one who has never had a passing thought about the stock market, asks me to show her how to buy "pot stocks." I saw dollar signs glowing like neon lights in her pupils. Apparently, my friend's co-worker was boasting to everyone in the office that her profits on a Cannabis stock she recently bought would end up paying for her kids to go to college. (I thought to myself, "Is she high?")

Her co-worker bought shares of a $0.05 cannabis company that has since hit an incredible high (pardon the pun) of $0.20. I didn't quiz my friend on the details of the trade, but let's suppose her co-worker bought 100,000 shares of CBIS at $.05 (just to give you some idea, the 50-day moving average of volume has increased from 3 million to 26 million in just the past month).

Since the stock is currently trading for $0.21, her $5,000 investment would now be worth $21,000. I sincerely doubt she bought that 100,000 shares, but regardless, that's not a bad return on investment. In fact, it's quite a carrot to dangle in front of my friend who thinks CNBC is about as fascinating as watching paint dry (she has the same opinion of my job).

The old adage, "there is no such thing as a stupid question" can be misleading. There are definitely stupid questions. I've even been guilty of asking a few myself. We've all heard them and we've cringed, maybe rolled our eyes, or had to take a deep breath before answering. I decided to go with that last option before addressing my friend's question. Her question shouldn't have been "how do I buy pot stocks?" but "should I buy pot stocks at all?"

As with any hot trend that takes the market by storm, she's not alone in her eagerness to cannon-ball into a pool of what she thinks are guaranteed profits. You see, would-be investors don't have any room to digest boring facts that aren't nearly as tasty as what the media is offering. But sometimes the stuff that has all the flavor of cardboard is what's good for us (and our bottom line), so I'm going to attempt to answer the question I think my friend should have asked...

Is now the time to buy 'Pot Stocks'?

I want to preface my answer with a quick look at what's been going on in this industry. 'Pot Stocks' have been tracked in the VectorVest database since 2004 (before most people knew there was such a thing). But the real buzz started November 2012 when the states of Colorado and Washington approved legislation to legalize both the medical and recreational use of marijuana.

The month prior to the legalization, October 2012, there were only four pot stocks: MediSwipe (MWIP), Medical Marijuana (MJNA), Cannabis Science (CBIS), Nuvilex (NVLX). Every single one of them penny stocks.

The industry's average closing price on 11/21/12 was $.06, the next trading day, 11/23/12, the industry average at the open was $12.25. Whoa! Wait a minute, the reason for the big change in average price is only partially due to the original group of stocks surging in price. The primary reason for the jump was due to a new guy being added to our database, Medbox (MDBX), at $61.00.

So let's take a look at MDBX.

Medbox deserves attention because it captures the insanity surrounding this industry. In less than one week, the stock shot from $4.00 to $215, then proceeded to fall to a (still insane) $100. Medbox's market cap shot through the roof, moving from $45 million to $2.3 billion.

Let me repeat, this was in less than a week.

Here's the thing that boggles my mind, though. The company's own founder, Vincent Mehdizadeh is quoted as saying, "We believe an appropriate trading range is between $5 and $10 but, alas, the market will do what it will do." As of February 10, 2014, Medbox is trading at $27.41, still several times greater than its value.

Below, you'll find a chart of the current pot stocks being traded, as well as VectorVest's valuation of these stocks. For more on VectorVest's valuation of stocks, go here.

Pot stocks

While Medbox may be just one of the extreme examples in this industry, its cannabis competitors aren't so different in their price behavior. Few of these stocks have any fundamental worth to recommend them. The majority have zero or negative earnings and every single one of them are trading at a premium compared to current value. The background of this industry clearly points to irrational exuberance grossly inflating stock prices.

At least for the time being, buying pot stocks is not even close to investing; it's extreme speculation. So, just to be clear, my answer to my friend would be no, now is not the time to buy stocks in this industry.

I happen to agree with Medbox's founder that "the market will do what it will do," or in my case, my friend will buy whatever she wants to buy regardless of any warning signs I post... and really, I'm no one to say she's wrong. Fortunes have been made on crazier market trends, like during the dot.com era. This could actually turn into something of real substance, but I would still have a few tips for her:

  1. Imagine, just for a moment, the worst possible scenario – legislation is reversed, marijuana is banned or regulation is so severe that it drives many competitors out of business. Perhaps lawsuits start coming out of the woodwork for accidents due to cannabis consumption (In our country? Never!). Whatever stock you own drops to zero. How much would you be okay with losing? Be honest with yourself. THAT, and only that, is the amount you should invest in this industry, because in the blink of an eye it could all go up in smoke (pun was entirely intended).
  2. Since you're hoping this is your golden goose, once you have doubled your money (your $0.10 stock moves to $0.20) consider selling enough shares so that you now have your original investment safely in cash.
  3. Buy shares of a few different companies (especially if you aren't planning to research who's who). I'm not encouraging you to invest more money, but spread whatever you're planning to use around. Very doable with penny stocks. Some of these companies have been trading for less than a month and more will be cropping up. If one gets wiped out, you've still got a shot with the others. Another interesting way to diversify is to buy one stock that has been performing well, hitting new highs but go bottom-fishing for the other.
  4. If you are planning to do a little research on 'who' these companies are (highly recommended), select stocks that have different functions within the industry – there's more variety to be had than just growers. For example, AVT (AVTC) produces vending machines that can be used as marijuana dispensaries and Growlife (PHOT) provides equipment and horticultural supplies for growing cannabis.
  5. Have a little patience. Wait for the Exchange Traded Fund (ETF). If this frenzy continues, there will no doubt be an ETF offered that will provide instant diversification, alleviating the stress of picking the right pot stock.

Today, 20 states have legalized marijuana in some form, making this industry one to watch. I might buy a few shares myself, but no more than I would risk at the blackjack tables in Vegas. I prefer to let early adopters shoulder the big risks.

As obstacles are cleared and leaders emerge, those of us that have hung back will still have plenty of time to profit (legally) from pot.

So what would I buy while I'm waiting around to see how the cannabis industry develops? Well, I hate to leave you with a cliffhanger, but that will have to be a topic for my next article.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Business , Stocks

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