Given the title of yesterday’s Market Musings piece and the subject of today’s, you, dear reader, could be forgiven for thinking that I have some kind of a drug problem. I can assure you that I don’t. I just have a problem with some drug stocks, both the non-conventional and more traditional. In yesterday’s piece I laid out my reasons for being bearish on the long term prospects for the manufacturers and suppliers of pharmaceuticals. Today it is the more controversial cannabis related stocks that have gained my attention.
The reason for interest in marijuana related businesses is obvious, at least to those who live in the US. Medical use of marijuana is now legal in nearly half of US states and recreational use of the drug has been de-criminalized in both Washington and Oregon. There is no shortage of people telling you that this is the next big thing and buying into pot related businesses is your chance to get rich quick. There are also those who, somewhat more soberly, advocate investing in companies looking at cannabis derivatives as pharmaceutical products.
These two different stories must be looked at separately. Here I am only concerned with the companies that are not listed on major exchanges and whose prospects depend on further relaxing of state and federal restrictions, not the likes of GW Pharma (GWPH) that are researching more conventional pharmaceutical products that happen to be derived from cannabis.
When it comes to these small stocks, there is a distinct smell of scam. The ubiquitous marketing promises enormous profits and most of the recommended companies have never made any money. There have been numerous investigations of small, pot-related companies by regulators. GrowLife (PHOT), Cannabis Group (CBGI), Advanced Cannabis Solutions (CANN) and others have seen their stock halted by the SEC. It doesn’t take a genius to see this as a warning.
The fact that some are bad, of course, doesn’t mean that all of the over the counter (OTC) traded small companies in the business are. The problem is that OTC traded stocks are not required to report company results and financials to the SEC. This lack of reporting makes it almost impossible for an average investor to distinguish the good from the bad.
The stocks’ OTC status also results in a serious lack of liquidity which makes pump and dump schemes an ever present danger. The price action in Medbox (MDBX) at the start of this year shows what a lack of liquidity can do. Medbox make a secure dispensing system that can be used for medical marijuana and other drugs. It was the potential marijuana application that led to MDBX going crazy in January. The stock jumped nearly 850% in a couple of weeks and then lost more than 60% of its value over 3 days.
I have said many times that those who trade or take an active role in managing their portfolio should embrace volatility and see it as opportunity, but there is a limit to that advice. If you see the history of MDBX as anything other than a dangerous trap for the retail trader, then you are probably beyond help.
I haven’t even got into the regulatory risk that is involved in investing in US based companies who are attempting to ride the wave of de-criminalization. I happen to believe that the legalization of marijuana at the federal level in the US is somewhat inevitable eventually, but that day could be a long way off. In the meantime the ongoing battle between the federal government and the states here in the U.S. makes government action somewhat unpredictable to say the least.
It is likely that, at some point in the future, some serious companies with decent prospects of profitability will emerge from the mess. The fact that a large percentage of the dotcom stocks so popular at the turn of the century were a failure shouldn’t disguise the fact that companies like Amazon (AMZN) have survived and thrived. It is just too early to predict which will be Amazon and which will be Pets.com. General hype can easily mask distinctions.
You would think that the fact that stock tips in the marijuana business are marketed so aggressively and so frequently would be warning enough for most investors. That doesn’t seem to be the case, however, as I am frequently asked about the prospects for these small companies. In each case my reply is a variation of the same thing. The only way I would invest anything in these companies at the moment was if I had over-indulged in their product.