Investing in Cannabis? Ask These 3 Questions Before You Do

Hello, readers! I’m excited to share my perspective on cannabis investing in The Cannabis Capitalist, a bimonthly column Leafly is debuting today. I’m a Houston-based Chartered Financial Analyst who’s been following the cannabis industry since early 2013, always with the goal of helping investors identify the real deals and avoid the pretenders.

My job: Help you identify the real deals and avoid the pretenders.

A lot has changed over the past four years. There are increasingly better options for investors these days, with more and more solid cannabis companies open to investment. That doesn’t mean there are no more landmines on the landscape, though.

I spend a great deal of time pointing them out to my subscribers at 420 Investor, which is focused on publicly traded stocks, and at New Cannabis Ventures, which covers both public and private companies.

Let me start with some of the basic factors to consider before investing in private or publicly traded cannabis companies.

The Private Side: Accreditation Required

Investments in private companies can be a much better deal from a valuation perspective. The downside is that investors have a more limited ability to sell their holdings.

These deals are typically available to accredited investors only, meaning you have to have $1 million in assets excluding your home or salary of $200K per year as an individual or $300K as a family. Once you meet those requirements the minimum investment is typically around $25,000, though in certain circumstances it can be lower or even substantially higher.

Finding private investment opportunities isn’t easy, as most investment banks are reluctant to work with the cannabis industry. Joining the Arcview Investor Network, an angel investing group, is one way to address that challenge. Arcview hosts weekly webinars where three to five companies pitch, as well as a quarterly in-person event in a rotating group of cities. Arcview presents its 600+ members with a highly selective group of pre-screened companies seeking investors. Well-known companies like Eaze and MJ Freeway received early private funding through the Arcview network.

The Public Route: Open to All

If you want to invest in public companies, which are open to anyone and have much better liquidity than private placement, you have more than 550 options. That’s how many publicly traded companies purport to be in the cannabis industry.

Don’t expect to find them listed on a major exchange, like NASDAQ or the NYSE. Almost all of the American cannabis companies I follow trade “over-the-counter” (OTC) and not on a major exchange. Many of these don’t file with the SEC, which is always an immediate red flag for any investor.

The OTC sector can be quite volatile. My proprietary Cannabis Stock Index, which which is rebalanced each quarter and currently tracks 50 stocks that meet certain liquidity and price criteria, went on a rocket ride in 2014 when Colorado opened its doors for adult-use cannabis sales. The Index rose seven-fold in ten weeks to begin the year, only to come crashing back down. In 2017, after an initial 35% rally, it lost about 44% of its value, leaving it down about 20% so far:

If you’re interested in funds rather than picking individual stocks, your options are extremely limited. I have identified one mutual fund (so bad I won’t mention it), and there is an exchange-traded fund (ETF), Horizons Marijuana Life Sciences Index ETF, which trades on the Toronto Stock Exchange with the symbol “HMMJ”. The Horizons ETF, which has assets of about C$120 million, has several issues that keep me from recommending it. Several other ETFs are in the process of coming to market, so hopefully we will see some better options in the coming months for those who want to invest in funds.

3 Questions to Ask

I’ve learned a few things tracking cannabis stocks for four years. Here are three questions to ask before committing your money:

• Are there better opportunities beyond companies that touch the leaf? Companies that grow, process, and sell cannabis products are popular with investors. But these companies also operate in extremely competitive sectors that could become commoditized. Consider investing in ancillary companies that will help the industry stay compliant or lower the cost of production.
• Are there opportunities outside the United States? Cannabis investing is a global opportunity, and the United States, where cannabis remains federally illegal, may not be the best market. Canada has a rapidly growing federally legal medical cannabis market that is expected to become legal for all adults in mid-2018. Germany is another potential opportunity, as it has legalized medical cannabis with pharmaceutical distribution and coverage by health insurance.
• Does the company I’m considering produce revenue? This is a relatively new question to ask about public cannabis companies. At New Cannabis Ventures, we’re updating and sharing a list of companies that are on track to deliver annual revenue of $10 million or more. So far we’ve identified a dozen companies, and the list is sure to grow. Revenue is just one criterion, but it’s a nice start. Until this year, investors were forced to choose among companies that offered promising ideas but few real results.

The bottom line: Investing in cannabis remains risky and challenging. For investors looking to capitalize on cannabis, though, the options continue to increase. California’s legalization in 2018, followed by Massachusetts, will further erode some of the stigma surrounding cannabis, improve the private and public markets for emerging companies, and offer ever-greater opportunities for cannabis investors.

Next up: How to distinguish between cannabis opportunities and cannabis opportunists. Talk with you in two weeks.