Should You Buy Pot Stocks Before or After Legalization?

When Canopy Growth Corporation was first listed on the TSX Venture Exchange in April 2014, long before there was any prospect of the recreational legalization of weed, its stock was trading at a mere $2.59. It was only in November 2016, when legalization was officially announced, that Canopy’s stock started to pick up steam. At its height, Canopy stock was trading at over $44 per share — it now hovers in the $33 - $35 range, more than 10 times the value it was in 2014.

Other big cannabis companies like Aurora Cannabis, Aphria Inc. and Cronos Group observed a similar growth trajectory, seeing their stocks burgeon in value over the short span of two years.

For early investors of pot stocks, their returns are more than made.

But for those who have been observing cannabis companies from the sidelines, pondering whether or not to get into the space now that stock prices of the biggest licensed-producers are significantly higher than they were two years ago, is now the right time to buy? Will pot stocks soar or crash after October 17th, when recreational weed officially becomes legal?

“Summer in Canada is a low period for the stock market, and October is a notoriously bad month for the market,” said Hamish Sutherland, CEO of White Sheep Corporation, a company that is both in the cultivation and investing side of the cannabis industry. “I’ve always said, buy on rumour, sell on news. And well, we know what the news will be on October 17th.”

“Stocks of the big companies have been falling lately, and its August, the stock market is usually slow. My guess is that you’ll get a run up starting September, up until October 17th, and then you might see some people freaking out and selling,” observed Alan Brochstein, an investment analyst and founder of 420Investor.com.

“There’s definitely a short-term trade to be made around legalization, but you’ve got to decide if you’re a short-term investor, or if you’re in this for the long-haul,” Brochstein said.

Indeed, in Canada at least, the cannabis industry is nascent. Companies like Canopy and Aurora, valued at billions of dollars on the stock market, haven’t even begun to sell to what will become their biggest customer base: recreational pot consumers. “The industry is going to go through a big change — these companies are going to go from concept stocks to real businesses and it’s important to separate the winners from the losers,” said Greg Taylor, Portfolio Manager at Purpose Investments.

So how do you pick out what companies to invest in?

“Canopy is the leader in the sector and they can always pull off what they say they are going to do,” Taylor said, alluding to the fact that Canopy is a good stock to buy, despite its high valuations. “If a company is a low-cost grower, is doing something internationally, or focuses on value-add products like oils and beverages, then I would say those are companies to consider investing in,” he added.

Brochstein takes a slightly different approach to investing in the big LPs. “I will say that I added four relatively new LPs that are small to my list lately because I think there’s much more opportunity with companies with lower valuations.”

“Lots of investors want to invest in the biggest companies — Canopy and Aurora — but I would say that’s not the smartest way to invest. Do I need to own the most expensive cannabis stock to invest in the cannabis market? Absolutely not.”

Taylor, who runs Purpose Investments’ cannabis-focused ETF — a basket of 12 cannabis company stocks which includes Canopy — has two additional pieces of advice for new investors getting to the cannabis space. First, don’t buy companies that are say they grow the best weed, and second, start looking at American cannabis companies listed on some of the smaller stock exchanges because they have the legal flexibility to brand themselves, and they are cheaper.

“Look, lots of companies say that they’re growing the best weed, and they have the best strains, but at the end of the day most consumers aren’t going to care about that stuff. It’s about who can create the best brand, and American companies are way more brand-focused because they can be,” Taylor said.

The Canadian federal government’s proposed packaging and labelling directives are strict — dried bud from all producers will have to be sold in uniform black or white bags, with one of six Health Canada warnings on them, and producers will only be able to display their brand logos on a tiny corner of the package. No such regulations exist in states like California and Colorado, whose pot companies have been allowed to be as creative as possible in marketing cannabis.

Sutherland too believes that what will end up being stand-out companies in a few years, are those who are able to master the art of branding. “The top companies in the Canadian market are reliable and safe to invest in right now. But I think over time, the companies that will stand out will be those that have brand association and a specific product — Molson’s partnership with The Hydropothecary, Constellation and Canopy Growth, Canntab Therapeutics that makes slow-release pills — those will be interesting to watch.”

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