The cannabis industry has great promise and pulling power but investors must do their research before chasing marijuana stocks as the space is heating up and is rife with short sellers and pump-and-dump schemes.
“Investors have stars in their eyes. My inbox is flooded with offers to make me a marijuana multimillionaire. Age-old “pump-and-dump” schemes are in full bloom in marijuana stocks,” warned analyst Nigam Arora, the author of The Arora Report.
“The most important pointer is to not fall victim to pump and dump schemes. In such schemes, certain stocks are heavily promoted. The stocks run up on the promotions. Those promoting the stocks buy them before they start pumping and then dump them when mom and pop start buying them,” warned Arora.
Canadian cannabis stocks have already floated to a collective stock-market value above C$30bn. That’s already about half the market capitalization of Canada’s gold mining industry.
Despite many of the major players in the cannabis space seeing double-digit gains this month on the back of Constellation’s record US$4bn investment in Ontario-based Canopy Growth Corp (NYSE:CGC), "Fast Money" trader Tim Seymour says the group has room to grow.
"What we're seeing cannabis traders do is they're rotating into US names, and that's something that ultimately I think you want to take a look at,” said Seymour.
While Canada's newly legalized recreational weed law sets up for a big growth opportunity, what’s also driving action is that the US market has the potential for 15 times the amount.
Bullish on cannabis
Vivien Azer, a beverage, tobacco and cannabis analyst at Cowen, says the cannabis industry will reach US$75bn by 2030. The top cannabis stocks she expects to outperform are Canopy Growth, MedReleaf which is now part of Aurora Cannabis Inc (TSE:ACB), and Kush Bottles Inc (OTCMKTS:KSHB), a medical wholesaler.
“Investors simply can't afford to sit this megatrend out as real marijuana sales and profits are materializing,” said marijuana investor Alex Farmelo. “A majority of Americans are in favor of legalizing adult use cannabis and that bodes well for the future.”
According to an October 2017 Gallup poll, 64% of US adults are in favor of legalizing adult use cannabis - the highest level of support in five decades.
Arkansas, Florida, North Dakota, Ohio, Pennsylvania, and West Virginia passed legislation allowing medical marijuana in the past couple of years. California's recreational marijuana market opened earlier this year.
Beware of short sellers
In a classic short-selling attack, pot stocks got smoked Thursday after Citron Research's Andrew Left came out with a vague report on Canadian cannabis company Cronos Group Inc (NASDAQ:CRON), giving it a price target of US$3.50. The market ate it up and Cronos dropped 28% on Thursday to around US$9.12 as 22 million shares were dumped. The stock has since bounced back 12.3% to trade at US$10.24 on Friday.
When asked whether Citron owns positions in Tilray or Canopy, Citron said it was shorting Cronos, according to Market Watch.
Citron’s note essentially cast a dark shadow over recent gains by Cronos, warning investors that while the end of prohibition in Canada is real, when the market shakes out, some of the 100-plus licensed producers will be decimated.
Citron alleged that Cronos was failing to reveal key details about its distribution agreements with Canadian provinces. “Cronos management appears to have been deceiving the investing public by purposely not disclosing the size of its distribution agreements with provinces – unlike every other major cannabis player,” warned the Citron note.
Investors who followed the herd, got caught up in Thursday’s panic-selling. Cronos stock recovered by the time trading resumed on Friday. “Some of these allegations appear to be unfounded and biased,” countered GMP Securities analyst Martin Landry of the Citron report.
Market Watch reported that in a note to clients Martin Landry said that Canadian provinces haven’t made fixed commitments to buy pot, rather that it was buying from a list of suppliers and would replenish the weed as needed — whichever products that sell the best. The provincial government-backed pot operations have “limited visibility” into what brands people will actually buy and so Cronos is being “prudent,” said Landry.
An investor could have sold into the panic, but here are the facts. Cronos announced one of the largest agreements to purchase a bulk amount of weed — 20 metric tonnes annually — which would amount to C$60mln (US$46.2mln) to C$80mln (US$61.6mln) in annual revenue.
According to Landry, Cronos has developed high-profile partnerships in the industry, which could make it a potential target for a global liquor-brand partnership.
According to experts, short interest in Canopy is 8.3% of the float, and in Cronos it is 12% of the float.
Expect high volatility
If the Cronos episode tells you anything, it is that pot investors must have nerves of steel and take the sharp swings in their stride.
“Expect these stocks to be very volatile,” said Arora. “Investors may want to take advantage of the volatility by selling into the strength and buying into the weakness.”
The extreme volatility also demand that investors should take advantage of opportunities to diversify their portfolio and not put all their eggs in one basket.
“One example is to diversify into stocks such as Zogenix, Inc (NASDAQ:ZGNX), GW Pharmaceuticals (NASDAQ:GWPH) and Zynerba Pharmaceuticals Inc (NASDAQ:ZYNE) and Scotts Miracle-Gro co. (NYSE:SMG) by scaling in on significant pullbacks,” wrote Arora in his report.
Contact Uttara Choudhury at [email protected]
Follow her on Twitter: @UttaraProactive