7 Essential Tips For Investing In Marijuana Stocks

Michael Vodicka's picture

Monday, May 15, 2017 - 2:30pm

by Michael Vodicka

Legal cannabis is the fastest growing industry in North America. In 2016, cannabis sales in the United States increased 30% from 2015 to reach $6.7 billion.

And looking forward -- with more states, Canada and countries across the globe moving toward legalization -- this already impressive pace of growth is actually set to accelerate. Canada's recent decision to legalize recreational cannabis by next summer is expected to create a $23 billion industry that could be bigger than beer and wine.

Cannabis industry research firm Arcview is predicting (PDF) that cannabis sales in the United States will increase more than 200% to $22 billion by 2020. Take a look below.

how to invest in marijuana stocks

This incredible opportunity hasn't gone unnoticed. Investors are clamoring for marijuana stocks. Cannabis stocks in North America have been among the most heavily traded securities this year.

However, while I do see great opportunity, investing in cannabis stocks also creates new challenges. At the top, there are more than 300 cannabis stocks to choose from. It's difficult to separate winners from losers. 

From there, buying, selling, and owning cannabis stocks is a lot different than investing in blue-chips such as Apple, Alphabet and Amazon.

But don't fret. I have been investing my clients and myself in cannabis stocks since 2013. In the last four years I have learned many valuable lessons about this young sector. And today I'm going to shares seven essential tips that will help you save both time and money and invest in cannabis stocks as profitably as possible.

Cannabis Stocks: What You Need To Know

1. Focus On The Largest Companies In The Sector
The cannabis sector is loaded with micro- and nano-caps. These are companies with market capitalizations of less than $250 million and $50 million, respectively. On one hand, these young companies offer tremendous growth potential. But on the other hand, they are prone to bouts of extreme volatility. That volatility can be driven by unexpected fluctuations in sales and earnings growth. It's also just a lot easier for big traders with billions to push around a $50 million stock. Focusing on the biggest companies in the cannabis sector helps moderate both issues.

2. Go International
Some of the best opportunities in cannabis are happening outside the United States. For example, Canada is set to legalize recreational cannabis by next summer. Israel has legalized medical cannabis and is moving toward legalizing recreational. Australia voted to legalize medical marijuana in the fall of 2016. Local companies listed on these countries' stock exchanges are scrambling to cash in.

3. Diversify
It's going to be difficult to separate winners from losers in the young cannabis industry. Some of these companies will grow into global leaders while others will fail and file for bankruptcy. This is the reason I recommend diversification. Owning a basket of marijuana stocks means that if one goes bust, your portfolio will survive.

4. Core Versus Peripheral Holdings
Within a diversified portfolio, it's a good idea to weight your holdings differently. Larger cannabis stocks should have a higher allocation while smaller, more speculative cannabis stocks should have a smaller allocation.

5. Focus On The Long Run
The cannabis sector is prone to extreme bouts of volatility. For example, in early 2014, the entire sector rallied more than 200%. But for the next 18 months, the cannabis sector fell into a nasty bear market where some stocks fell more than 50%. You can't worry about this volatility too much and let it distract you from the big picture. The real opportunities in cannabis will unfold over the long run.

6. Don't Sweat Valuation
Expectations for cannabis stocks are running high. Investors are very excited about this opportunity. That exuberance is on display in these companies' valuations. Some of the most popular cannabis stocks have valuations that look absurd compared to the S&P 500. You'll hear some voices bashing these valuations an unsustainable. While there is some merit to that, don't let this criticism prevent you from seeing the big picture opportunity.

7. Use Limit Orders
Buying cannabis stocks can be a lot different than buying a blue-chip such like Alphabet. Spreads in cannabis stocks can be much wider than blue-chips because of their smaller market caps and lower daily trading volumes. When buying or selling cannabis stocks, I recommend always using limit orders. This will help you avoid price slippage on your entry prices.

Risks To Consider: Cannabis stocks are prone to extreme bouts of volatility. These stocks can easily fall 50% for what seems like no reason and then rebound to new highs for what once again seems like no reason. You have to be prepared to accept that volatility to be successful investing in the cannabis sector.

Action To Take: If you're thinking of investing in cannabis stocks, then keep these tips in mind. You're going to hear a lot more about this sector in the coming months and years. Stay tuned with StreetAuthority for the most up-to-date marijuana stock recommendations. For our most recent picks, check out my latest articles on the subject here and here

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Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.