Investing in the Cannabis Industry & Financial and Legal Risks
The cannabis industry has grown by leaps and bounds following the legalization of marijuana in many states. This makes it an attractive target for investors, although anyone considering marijuana stocks should understand the high risks involved. They should research the distinctive nature of cannabis businesses and applicable regulations to make sure that this is the right choice for their financial goals. One important point to bear in mind is that the industry is constantly changing. Investors must devote the time needed to stay up to date on the latest developments, including changes in the law, so that they can make smart decisions.
Some cannabis businesses focus on medical marijuana, while others focus on recreational marijuana, and still others handle both forms. Investing in medical marijuana is similar to investing in the pharmaceutical industry. Recreational marijuana has a broader market, but it tends to be heavily regulated and taxed. In either medical or recreational marijuana, several different types of companies can present opportunities for investors. These include cultivators, harvesters, and retailers, as well as biotechnology companies that use substances found in marijuana to create pharmaceuticals. Certain other types of companies do not work directly with cannabis plants but instead facilitate the cannabis industry by providing neutral products and services, such as lighting or packaging.
Risks of Investing in the Cannabis Industry
Although support has grown for legalizing marijuana nationwide, it remains a prohibited substance under federal law. This means that cannabis businesses often struggle to obtain financing and other routine services through banks, which can make their funding more tenuous and their operations more cumbersome. Some of these new companies may not be profitable at the outset and may face a constant threat of exhausting their capital. In response, they may issue new shares to generate fresh capital, but this process reduces the value of shares currently held by investors and may not even provide a lasting solution.
Since the cannabis industry is still new, the balance between supply and demand can be uncertain and prone to fluctuations. For example, a cannabis cultivator may invest substantial resources in expanding production, only for demand to drop. If supply exceeds demand, the prices of marijuana products may fall, causing businesses and investors to lose money.
If a cannabis business trades over the counter, it does not need to file regular financial statements, so investors may not know the extent of the risk that they are undertaking. In addition, over-the-counter cannabis businesses are free from minimum market capitalization requirements. This can hinder trading their stock.
Choosing a Cannabis Investment
An investor considering the cannabis industry should investigate the growth strategy of a potential investment target. They should examine the financial statements of the company, and they should assess the skills of its management. An investor may want to think twice before investing in a business that has issued a large quantity of warrants and convertible securities on a percentage basis. This could signal a future drop in the share price because the stock may be significantly diluted.
Cannabis cultivators with lower cost structures likely have a more competitive position in the market. When an investor is exploring these types of investments, therefore, they will want to consider the all-in cost of sales per gram and the cash cost per gram. The all-in cost is the total cost of producing cannabis, while the cash cost takes this figure and subtracts costs related to packaging, inventory adjustments, and amortization.
In general, an investor should not venture too deeply into the cannabis industry until they have become familiar with it. They should limit their initial investment to a small position and monitor developments in the industry before expanding. If the investment proves too unstable, they can withdraw without suffering serious losses.
