How to invest in cannabis stocks
We share an approach that could be used as a frame of reference to start investing in the cannabis industry recognizing the different risks.
Global cannabis markets are showing attractive growth in terms of sales, companies, products and the opening of new markets via legalization in different countries. This situation draws the attention of investors and postulates what appears to be a great investment opportunity with high growth and risk. Given this panorama, we share an approach that could be used as a frame of reference to start investing in the cannabis industry, recognizing the different risks.
1. Understand the types of products
The first thing is to understand the main categories of products that exist:
- Medical cannabis products: Medical cannabis is legal in most states in the American Union and the process to acquire it begins with a prescription from a specialist to treat conditions such as anxiety, pain, stress and pain.
- Cannabis products for adult use: This category focuses on products with a recreational purpose and its penetration in terms of legalization is lower.
- Cannabis products for wellness use: This category is not recognized in terms of legislative texts, however, it is being created and supported by different marketing strategies for the placement of products mainly based on CBD or for topical use seeking a feeling of wellness.
2. Know the different types of cannabis stocks that exist
- Cannabis growers and retailers: These companies grow cannabis in greenhouses or outdoor facilities, harvest the crops and distribute to the end customer either with their own dispensaries or as suppliers to the retailers.
- Cannabis-focused biotech companies: These biotech companies are focused on developing drugs using cannabinoids.
- Companies supplying products and auxiliary services in the supply chain: These companies focus on providing raw materials for growers (lights, hydroponic systems, pots, packaging, logistics).
3. Understand the risks of investing in cannabis stocks
All investments have a degree of risk and cannabis stocks are no exception as they have specific dangers:
+ Legal and political risk: Although we can argue that the political risk as legalization advances in the world is decreasing, currently we are in an environment where the ways in which the industry will operate remains uncertain. We have a situation where the banking in the United States of cannabis companies is not allowed since it is not legal at the federal level.
+ Imbalance in supply and demand: Due to the opening of new markets and the participation of new players in the industry, we can observe imbalances in supply and demand, which causes producers to have a very high variability in their sales / profits. that causes volatility in stock prices.
+ The shares called Penny Stocks : Many of the titles that we can find today are considered penny stocks , that is, their capitalization value is below a company listed in the S&P 500 and the price of the share is generally less than the 5 dollars. They have the characteristic that they do not have a history that makes the market trust them and they tend to be highly volatile and speculative, in addition to that they can have low liquidity which results in risks to be able to enter and exit at a specific price.
+ Financial risks: Many of the companies follow the strategy of dominating the market. However, this usually means high levels of CAPEX, which compromises profitability and cash flows. This strategy often leads to rounds of capital raising via convertible debt, resulting in dilution of equity and a drop in the share price.
4. Different considerations for seeking a stock
- Research of the management team, as well as the strategy of the company.
- Know the strategy and its competitive advantages.
- Find a brand with a favorable financial situation, that is, low debt and positive unit flows.
- Know the conditions under which the company acquires debt. For example, if it raises capital via debt convertible into shares, that company has a higher risk of dissolution if those options are executed.
- Companies at an advantage with respect to their production cost per gram.
5. How to control risk
Understanding your risk profile as an investor defines many of the answers to the question of how you control risk. It is important to define the term and the base assumptions with which we are making the decision, currently the actions of cannabis companies are considered high risk due to their volatility and the short execution time of their strategy.
There are undoubtedly companies that are riskier than others, as well as funds (ETFs) that reduce your risk by offering diversified baskets of cannabis stocks.
Regardless of whether they decide to enter a specific stock or a diversified fund, it is important that they know the vehicle and define an amount with which they are comfortable to risk.
6. Continuous monitoring of industry dynamics
The cannabis industry, being at an early stage, has important changes in terms of the legal and commercial framework of each country, the United States being undoubtedly the most representative.
It is important to promptly monitor the shares we acquire, as well as the industry in general, as an example of something that can have a positive effect on the price and valuations of cannabis companies in the United States would be the federal legalization of cannabis, as well. such as the possibility of banking operations in the industry that currently operates 100% in cash.
We are at the beginning of an industry that promises exponential growth, doing a good job of selection and monitoring should result in good investment decisions in the medium and long term.
7. Investments live and in markets like Mexico
Live investments are those in which they invest directly in the company, these investments implicitly bring a much greater liquidity risk, that is, at the moment you want to sell the shares there is no secondary market in which you can do it quickly. They are also often the most profitable if your business model works.
From the perspective of the company, they usually look for capital, synergies and specific investor profiles from which they can leverage the business model.
In markets such as Mexico, where we are at the beginning of the industry where investment project efforts are beginning to seek capital, it is very important to know well the strategy and the parties involved in order to find the good projects and discard the projects that only they want to raise money with quasi-fraudulent schemes.
If you are an investor willing to get involved in the path of the company and you contribute something as added value, it is certainly a good option to look for this type of investment. If you prefer exposure to risk without involvement, stock investments are the best option.