Blog : Marijuana Stocks Will Land Hard

Whether you are a proponent or opponent of legalization, one fact is certain - the shares of companies in the marijuana world are dramatically overvalued. When they return to realistic prices, investors will potentially take devastating losses.

Typically, shares trading at over-inflated values is not a problem.  In fact, the price of any stock is only too expensive if it doesn't go even higher.  Buyer beware is the order of the day for any investment.  However, the situation surrounding pot stocks has created something more sinister.

Consider that for many investors, sinking some money into pot stocks is often their first foray into the stock market.  The endless drumbeat of marijuana stories in the news will continue to pull people in.  For many inexperienced investors the logic is sound - marijuana is growing in legalization and acceptance, so pot-related companies must be a good investment.  People have watched some of the cannabis stocks multiply ten times in value, and their response is to throw their savings at the industry in an attempt to also get just as rich, just as quickly.  Unfortunately, this story does not have a happy ending.

About 100 years ago, there were over 1,800 car companies.  While the automobile was and is a great idea, only three of those businesses have survived.  The others went bankrupt, or merged with another automobile company and went bankrupt, or were taken over by another car manufacturer and went bankrupt.  No matter which path the shares took, investors were wiped out.  No matter how great and important the idea, almost all of the people who committed their money lost 100% of it.  It was actually not much different for railway stocks, or speculators during the Gold Rush, or Internet companies around the time of the dot com bubble.  

As a Multiple Sclerosis sufferer, my interest in the documented medical benefits of cannabis in MS is significant.  However, as a speculative stock analyst, my concerns for investors is equally as significant.  The hunger surrounding pot stocks is almost comparable to the Dutch Tulip Bulb mania, the greatest difference being that we should know better.  After all, we know how this is going to end - the Dutch didn't have the luxury of historical precedent.

Even for those choosing to ignore the lessons of the past, hopefully they could rely on their common sense.  Is it logical to buy shares of a company valued at nearly a billion dollars while only achieving $2,000 in revenues for the entire year?  Or an oil and gas business on the verge of bankruptcy, who added marijuana to their focus, only to see their shares multiply significantly in value.  Or how about one with $9,000 in current assets, against nearly $6 million in current liabilities?

Yes, these are actual numbers from actual cannabis companies.  The names are intentionally withheld, but it's not hard for any investor to look into the finances of any publicly-traded company to see the train wreck for themselves.  The problem is that the investors clamoring to dive into the pot stock mania are not the ones reading the financial statements.

Despite the ridiculously ramping stock prices, the true depth of the stampede became clear at the first Cannabis Business Summit in Denver, Colorado.  After an appearance on a radio show in San Francisco, California, to discuss pot stocks, I was asked to be on a panel at the Summit focused on marijuana-related penny stocks.  While I expected it to be a discussion of the dangers in the shares of these over-priced investments, the room was actually full of individuals looking to get their own companies into the pot business.  It felt like a mob of people who were trying to upgrade their Stateroom as the Titanic sank.

Society seems to be undergoing a shift towards recreational marijuana legalization, but it important to recognize that we are still closer to the beginning than the end.  There is much to play out for the pot industry.  Expect to see ongoing media coverage of the topic, specifically now that we are about one year out from recreational pot legalization in Denver, Colorado.  While awareness is a good thing, an unfortunate side effect will be even more inexperienced, well-intentioned investors tossing their money into the bottomless marijuana stock pit.

Media coverage will eventually fade, just as it does with ANY story, whether the focus is on Occupy Wall Street, the war in Afghanistan, Bitcoin, or the missing Malaysian airliner.  Unfortunately, by the time the spotlight of the news shifts, it will already be much too late for investors who got involved with pot stocks.

Legalized recreational cannabis will also get another media bump in the coming months, as enough data has been collected, and enough time has passed, to make some important conclusions.  Did legal pot make the crime rate spike?  How much tax revenue has been generated?  Has marijuana been serving as a gateway drug to more serious substances?  The entire nation has been watching closely to see the answers play out.

The quick answers to these questions are incredibly encouraging.  According to the Colorado Department of Public Safety, the crime rate has fallen significantly year over year for the first few months of legalization, in terms of property crimes (-14%), homicides (-67%), violent crimes (-2.4%), and robberies (-7%).  The State is expected to pull in ten of millions in tax revenue, according to the Colorado's Department of Revenue, but they have had to adjust their expectations down from $60 million in the first full year, to closer to $25 million.  Unfortunately, whether or not marijuana is a gateway drug does not seem any more clear.

What is clear, however, is that every story relating to recreational cannabis drives more investors toward the cliff.  They throw their dollars over the edge, and hope their pot stocks grow big enough to catch them when they land.