The month of October was terrible for the marijuana Exchange Traded Fund MG Alternative Harvest ETF (MJ). After some months in which we witnessed the share price of the marijuana ETF climb higher, we saw it drop like a rock following the October 17 date for the legalization of marijuana in Canada. For October, MJ was down just slightly more than 27%.
MJ rose and fell due to some big winners followed by big losers in the marijuana industry. But the problem is, the moves we have seen by these stocks have for the most part been based solely on speculation and rumors. We have not received an earnings report indicating profits from Canada were going through the roof; we receive any real meaningful information from the companies themselves that would have indicated now was the time to buy because the stock prices were just going to run higher. It was all just speculation and hype that was causing stock prices to move higher. I recently warned investors that now was not the time to jump on the MJ train, back when the ETF was at loftier levels, but now that is has fallen, you should remain on the sidelines and see how things play out in the industry.
The first reason of why is because of the recent decline the industry has gone through. The majority of the drop has been due to nothing more than profit-taking after the boom, ‘hype cycle’ played out leading up to the October 17 legalization of marijuana in Canada. Common sense would say the marijuana stocks would climb higher after the law went into effect. But all too often, the opposite happens because the ‘hype’ over the recent change dies off after the actual event takes place, and no new information comes available to keep the ‘hype train’ rolling. Savvy investors bought shares of the marijuana stocks ahead of the legalization date, road those stocks higher due to the “hype” and then sold them after the October 17th date when the catalyst for the move higher played out.
Which leads us to reason two of why you should stay on the sidelines. Now that the law has gone into effect and marijuana is legally being sold, the next catalyst is going to be company earnings. The earnings reports from the companies in the industry will now dictate where the marijuana stocks go moving forward. We will not likely begin seeing earnings reports for some time, and when we do, we will have a better idea of how to value these companies. Maybe you think that early sales reports indicated Canopy (CGC) and Tilray (TLRY) sold out of their products in just a few hours on October 17. While that on the surface appears to be good, it is also just a tiny little snapshot of what is happening with these firms. Plus, selling out of a product on day 1 isn’t always a good thing. It could be an indication of bigger issues like supply chain problems or that the pricing of products was too low, which could be a sign that margins will be thin.
And again, that leads us to reason number three. The sale of marijuana leaf, which is what the Canadian bill specified could be sold, is a typical a low margin product for marijuana companies, as we have seen in US states like Colorado and California. Edibles such as gummies, cookies, brownies are the higher margin more profitable items that marijuana companies want to sell. But those are still illegal in Canada currently. This could all lead to weak earnings from the companies who have large exposure to Canada due to the costs of running these businesses.
Furthermore, because margins will likely be low in Canada's marijuana industry, only the best, most efficient running businesses will survive. And at this point in the game, figuring out who that will be without seeing earnings reports since the legalization in Canada has occurred is extremely difficult to determine.
The last reason is another that most people aren’t talking about and many assumed would just “go away” on its own, but the reality is that marijuana’s black market is going to be tough to squash. We have already seen the black market in California not only regain its pre-legalization strength, but some think it may even have become stronger than before. The increased regulation, hoops to jump through and taxes have pushed some of the growers, shop owners, and middlemen back into the shadows in California. Furthermore, due to the “lower” costs of doing business when you are part of the black market, the unregulated dispensaries in California can and are offering the same products at a much cheaper price than those operating within the constraints of the law. This once again will certainly be a factor that could hurt margins and or revenue outright.
I fully understand that after seeing a big decline that it is very tempting to jump in “before the price rebounds,” but with MJ and the other marijuana investments, investors should remain on the sidelines just a little while longer. Waiting to see how the industry plays out and what earnings reports reveal is hard, but will be well worth the wait if it saves you a boatload of money.
Warren Buffett’s #1 rule of investing is “Don’t lose money!” This is the perfect scenario to put that advice to good use.
Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513
Disclosure: This contributor did not hold positions in any company or investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
