Personal Finance

'Don't try to be Warren Buffett' with pot stocks: Analyst

The cannabis industry could be in for a serious buzz kill
The cannabis industry could be in for a serious buzz kill

While the legal status of cannabis companies may be in question, investors have more options to own a stake in these businesses.

Cannabis has strong growth prospects. Legal marijuana sales are projected to reach close to $22 billion by 2021 from nearly $7 billion last year, with a compound annual growth rate of 26 percent, according to Arcview Market Research, a San Francisco-based cannabis research firm.

In eight U.S. states, it is legal for adults to use marijuana recreationally and more than half of states have legalized it for medicinal purposes (see map below). GreenWave Advisors, another cannabis research firm, predicts that all 50 states could legalize weed within the next four years and the industry would be worth $30 billion.

The administration of President Donald Trump may diminish those optimistic outlooks. Attorney General Jeff Sessions has said he is "dubious" about the benefits of medical marijuana. In February, White House spokesman Sean Spicer said that he expects states to be subject to "greater enforcement" of federal drug laws and that Trump sees a " big difference" between medical and recreational marijuana.

Supporters of the marijuana industry point to other comments that Sessions has made about keeping Obama-era enforcement rules, known as the Cole memo. That document, written by then-deputy attorney general James Cole, outlines how states and marijuana distributors can avoid running afoul of federal drug laws.

"The Cole memorandum set up some policies under President Obama's Department of Justice about how cases should be selected in those states and what would be appropriate for federal prosecution, much of which I think is valid," Sessions told reporters after a speech in Richmond, Virginia.

The administration is reviewing the policy, but nothing has actually changed yet.
Mason Tvert
spokesman for the Marijuana Policy Project

Sessions also cast doubt on the resources the Justice Department has to restrict marijuana use in states where it is legal for medical or recreational purposes. "[I]t's not possible for the federal government, of course, to take over everything the local police used to do in a state that's legalized it," he said.

However, some say speculation about a federal crackdown is overblown. Mason Tvert, spokesman for the Marijuana Policy Project, an advocacy group dedicated to changing state and federal marijuana laws, told CNBC that "the Cole memo is still current policy. The administration is reviewing the policy, but nothing has actually changed yet."

As the Justice Department tweaks its weed policies, activists are working on the state level. Cannabis supporters are pushing for a ballot initiative for the 2018 midterm elections to legalize and regulate marijuana in Michigan. Tvert said the Marijuana Policy Project is focused on state legislatures in Connecticut, Delaware, Illinois, Maryland, New Hampshire, Rhode Island, Texas and Vermont to push for laws that would regulate marijuana like alcohol by 2019.

"The whole legal industry has been based on the premise that the federal government will not enforce the rules," said Alan Brochstein, a chartered financial analyst and founder of 420 Investor, a subscription-based service for investors interested in publicly traded cannabis stocks.

'Don't try to be Warren Buffett' with pot stocks

Beyond the legal issues, the problem for investors is that the industry is filled with small publicly traded companies that are risky bets at best, and outright fraudulent at worst.

Earlier this month, the Securities and Exchange Commission filed a complaint against a California company claiming to be a leader in the marijuana industry while it was booking sham revenue from a secret affiliate. The founder of that company agreed to pay $12 million in penalties, which is nearly triple the current market capitalization of the stock.

The SEC and the Financial Industry Regulatory Authority have issued investor warnings about marijuana-related penny stock fraud for years.

It underscores the problem that publicly traded cannabis companies are a highly speculative bunch. Most shares trade in over-the-counter markets and do not have to file audited financial reports with regulators.

All these companies are overvalued. If you try to be Warren Buffett, you won't buy any of these stocks.
Alan Brochstein
founder of 420 Investor

The Marijuana Index and 420 Investor have created benchmarks to track cannabis companies trading in the U.S. and Canada.

"I don't want people to invest in my index, because there are some crappy companies in it," Brochstein said. He advises investors to use his customized portfolios instead — yet even those are extremely volatile and only for investors with a high appetite for risk.

That is not to say that all marijuana-related companies are suspect. If you are planning on picking individual cannabis stocks, Brochstein recommended focusing on revenue and avoid companies with "professional penny stock executives."

"All these companies are overvalued. If you try to be Warren Buffett, you won't buy any of these stocks," Brochstein said.

Many of the marijuana-related companies that investors can buy stock in aren't "plant-touching." That means these companies supply goods and services to marijuana growers and distributors, or derive some commercial benefit from cannabis rather than dealing with the actual weed.

Good examples of these types of companies are lawn-care products maker Scotts Miracle-Gro, which have been acquiring hydroponics businesses, British biotech company GW Pharmaceuticals, which has a pipeline of cannabis-based drugs, and real estate investment trust Innovative Industrial Properties, which buys buildings and leases them to growers of medical marijuana.

Cannabis funds

Meanwhile, investors may soon have access to a U.S. marijuana exchange-traded fund (ETF). The ETF Managers Trust, which has helped launch instruments that invest in whiskey, big data and cybersecurity stocks, filed paperwork with the SEC to create the Emerging AgroSphere ETF.

The proposed ETF tracks an index that invests in a group of 69 companies that are involved in the medical marijuana and industrial hemp industries. The fund will not invest in companies that make any money from recreational pot sales.

If the SEC lets the Emerging AgroSphere fund make it to market, it would not be the first cannabis-focused fund. That honor goes to the American Growth Fund Series Two E, which invests up to 80 percent of its assets in the cannabis industry.

Baby boomers are the fast-growing segment of cannabis users.
Isaac Dietrich
co-founder and CEO of MassRoots

The fund, which was started in 2011, changed its mandate last year to focus on marijuana companies. So far in 2017, it generated a 3.3 percent loss and lagged the by nearly 10 percentage points. The fund's fees are no bargain, either. It charges a 5.75 percent sales load when you invest and a 1 percent expense ratio and a 0.30 percent 12b-1 fee.

These funds may benefit from a cannabis boom, but for now "the industry is mostly made up of mom-and-pop businesses," said Isaac Dietrich, co-founder and CEO of MassRoots, a mobile app and social network for marijuana users. He is encouraged by institutional investment in cannabis companies and the wider acceptance of legal pot by the public.

"Baby boomers are the fast-growing segment of cannabis users," Dietrich said.