The 3 Biggest Mistakes Made By Marijuana Investors | The variegated fool

Look no further, but marijuana stocks are once again blazing hot.

Pot containers have been on fire since early November, following an approximately 19-month lull (April 2019 to October 2020), where they grossly underperformed. E.g ETFMG Alternative Harvest ETF, which owns shares in dozens of direct and supplementary pot players, has risen 129% since the end of October.

A clear jar filled with cannabis buds lying on its side on top of a small pile of cash.

Image source: Getty Images.

If you are wondering what has changed, look no further than political composition in the United States.

For years, the Senate has been under Republican control. Former Senate Majority Leader Mitch McConnell, who is openly opposed to the legalization of cannabis at the federal level, used his power in the upper house of Congress to ensure marijuana legislation did not reach the floor for a vote. With Democrats now in control of the Senate, the House and the Oval Office, it is more likely than ever that we could see real cannabis reform at the federal level. This would open up the capital markets for cannabis companies, allow transportation between states and remove barriers to entry for Canadian pot holders. In other words, the largest marijuana market in the world would be open for business.

But as the hype once again builds around cannabis, I can’t help but point out three of the biggest mistakes marijuana stock investors continue to make.

A black silhouette sketch of the United States, partially filled with cannabis baggies, rolled joints and a scale.

Image source: Getty Images.

1. They count their chickens before they hatch

One of the most common mistakes made by pot stock investors (and I include myself in this amount) is to count their chickens before they hatch.

As an example, when Canada lifted the curtain on the sale of weeds to adults in October 2018, it was widely expected that our neighbor to the north would become a cannabis leader. It was the first industrialized nation to approve recreational marijuana, and many of its licensed producers had expanded their production capacity to meet demand.

But when the sale actually began, and in the months and quarters that followed, it clearly followed that Canada was (sorry pun) chronically unprepared for legalization. Federal regulators eventually delayed the launch of higher-margin derivatives by a few months, while select provincial regulators (ahem, Ontario) announced the opening of new pharmacies. Overall, most Canadian licensed manufacturers expanded on the capacity front.

We may well be witnessing investors coming ahead of themselves on the legalization front in the United States. While there is no doubt that the likelihood of legalization has significantly improved with Democrats controlling the legislature, it is far from a lock. Without a filibuster, ten Republicans would need to support the legalization of cannabis at the federal level. And even if that were to happen, President Joe Biden would have to sign the bill. Biden has previously fought on decriminalization and reorganization of weeds – does not legalize it.

The “this time is different” ideology could come back to bite pot stock investors again.

A person holding a magnifying glass over a company's balance sheet.

Image source: Getty Images.

2. They ignore dilution

Another big mistake that could cost pot stock investors a lot of money is to ignore stock-based dilution.

In Canada, banks do not lend much considering how poorly the Canadian pot industry has performed over the past two years. Meanwhile in the US, some banks and credit unions has completely avoided the cannabis industry for fear of being subjected to criminal and / or financial sanctions in the future. Providing basic banking services to U.S. pot holders will technically constitute money laundering as long as cannabis is listed as a Schedule I substance at the federal level.

To some extent, it makes sense that it is not profitable marijuana stocks regularly resort to selling their shares or issuing convertible debt as a way of raising capital. But the level at which some companies will drown their shareholders in market offerings and convertible debt issues is astounding.

Aurora Cannabis (NYSE: ACB), which has long been one of the most popular pot holders among millennial investors, is the perfect example of a cannabis company that continues to destroy shareholder value through dilution. Between June 2014 and the end of 2020 Aurora’s outstanding stock count ballooned from about 1.35 million to north of 186 million. That’s an increase of almost 13,600%!

Aurora has used its stock to finance day-to-day operations as well as to finance more than a dozen acquisitions, almost all of which pay handsomely for it. Even with this violent dilution, Aurora’s long-term future remains in doubt, as evidenced by the Canadian $ 243 million in cash it burned through between July 1, 2020 and December 31, 2020.

Long story short, ignore dilution of pot containers at your own risk.

A magnifying glass is held over stacks of coins that are on top of a financial newspaper.

Image source: Getty Images.

3. They are chasing hashpenny stocks

The third mistake that can prove to be the most expensive of all is that marijuana stock investors are suddenly obsessed with hunting penny shares.

Over the past few weeks, retail investors on Reddit’s WallStreetBets forum have effectively teamed up to pile on heavily shorted or cheap stocks. This has sent people like Solar growers (NASDAQ: SNDL) and MedMen Enterprises (NASDAQOTCBB: MMNFF) into the stratosphere.

The problem is penny stocks are usually low price for a very good reason.

Sundial Growers, which is perhaps by far the most popular stock on Wall Street right now, has been issuance of shares such as water and conversion of debt into equity. Since the end of September, the company’s outstanding share count has ballooned from just over 500 million to 1.56 billion. That’s right – the company has issued 1 billion shares in about four months. This level of dilution should definitely scare investors.

MedMen is its survival remains in doubt. It ended September with just over $ 10 million in cash and cash equivalents, though it raised $ 25.7 million in early November. Nevertheless, it is a shame compared to the net loss of $ 30.1 million recorded in the September quarter. MedMens overzealous expansion and unresponsive former management team may have dug a hole so deep that the company can never recover.

There are good marijuana stocks that investors can buy. However, chasing cannabis earbuds is not the way to get rich in this fast-growing industry.

This article represents the author’s opinion, that may disagree with the “official” recommendation position for a Motley Fool premium advisory service. We are motley! Questioning an investment dissertation – even one of our own – helps all of us think critically about investing and make decisions that help us become smarter, happier and richer.

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