Avoid these mistakes when investing in marijuana stocks.

It’s been a good year for marijuana investors, with many of the largest U.S.-listed marijuana stocks up 30% or more year-to-date. When the market is hot, making money can seem easy to investors. A rising tide and positive momentum can make it seem like cannabis investors can do no wrong. In reality, strength in the cannabis stock group may actually be helping to mask some common mistakes cannabis investors are making. Big returns in the marijuana space won’t always be so easy. Here are 13 investing mistakes for cannabis investors to avoid.

Next:Not enough diversification. Credit

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Not enough diversification.

With cannabis stocks like GW Pharmaceuticals (ticker: GWPH) and Canopy Growth Corp. (CGC) showing big returns, it’s tempting to increase portfolio allocation to cannabis stocks. However, the more concentrated a portfolio becomes, the more risk is created. If anything, cannabis investors should consider rebalancing their portfolios by selling some of their stocks that have performed best this year. Given the extreme volatility among cannabis stocks and the high risk associated with such early-stage growth companies, it’s wise to diversify into a basket of cannabis stocks or a cannabis ETF rather than focusing on one or two companies.

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Avoid these mistakes when investing in marijuana stocks.

It’s been a good year for marijuana investors, with many of the largest U.S.-listed marijuana stocks up 30% or more year-to-date. When the market is hot, making money can seem easy to investors. A rising tide and positive momentum can make it seem like cannabis investors can do no wrong. In reality, strength in the cannabis stock group may actually be helping to mask some common mistakes cannabis investors are making. Big returns in the marijuana space won’t always be so easy. Here are 13 investing mistakes for cannabis investors to avoid.

Not enough diversification.

With cannabis stocks like GW Pharmaceuticals (ticker: GWPH) and Canopy Growth Corp. (CGC) showing big returns, it’s tempting to increase portfolio allocation to cannabis stocks. However, the more concentrated a portfolio becomes, the more risk is created. If anything, cannabis investors should consider rebalancing their portfolios by selling some of their stocks that have performed best this year. Given the extreme volatility among cannabis stocks and the high risk associated with such early-stage growth companies, it’s wise to diversify into a basket of cannabis stocks or a cannabis ETF rather than focusing on one or two companies.

Assuming online information is reliable.

With more cannabis stocks listing on U.S. exchanges and an increasing number of Wall Street analysts covering marijuana, it’s easy for cannabis investors to let their guard down in performing due diligence. In reality, many cannabis stocks are still micro-cap stocks that trade on the over-the-counter market, which has much more relaxed standards for financial reporting than the New York Stock Exchange or Nasdaq composite. OTC-listed Medmen (MMNFF), which is covered by seven analysts, recently issued a news release distancing itself from “exaggerated or misleading statements” made by Winning Media, a company Medmen had hired to help promote the company.

Not researching carefully.

Reading news releases and commentary from other marijuana investors alone can be very misleading, even if the company is not trying to be misleading. Any company’s public relations team and management is tasked with painting an optimistic picture of how the company is performing and the direction it is headed. In addition, there are plenty of websites out there devoted to marijuana investing commentary that are funded by pro-legalization groups or other sources with conflicts of interest. Only rely on verifiable information that comes from well-established news sources or analysts and experts from reputable companies.

Believing U.S. federal legalization will be quick.

Following the recent national legalization of recreational cannabis in Canada, cannabis investors are looking forward to the U.S. following suit. Unfortunately, despite popular support nationwide, marijuana legalization may take longer than expected. Marijuana will likely not be a top-priority issue for representatives seeking reelection compared to more pressing issues like health care reform, the economy and immigration. Finally, the pharmaceutical drug lobby is by far the most powerful and influential political lobby in the U.S., according to OpenSecrets.org. Expect the pharma lobby to fight marijuana legalization tooth and nail to help preserve their prescription drug business.

Not understanding the regulations.

Micro-cap companies typically have extremely small management teams, yet the regulations dictating the cannabis business are extremely daunting. If a business doesn’t take a careful approach to regulations, the company can easily end up in hot water with regulators. There are several ways for investors to get a sense of whether or not a cannabis company is taking regulations seriously. Investors should look for involvement with industry associations. Hiring managers or advisors that are regulatory or compliance experts is also a good sign. Finally, a clearly-defined compliance procedure is a signal a company is taking regulations seriously.

Focusing on high-risk stocks.

It’s natural to pick stocks with the most potential upside. Fortunately, if the marijuana bull case plays out the way many analysts anticipate, the marijuana market will ultimately be so large that even the most well-established market leaders in 2019 will have plenty of long-term upside. An under-the-radar, micro-cap OTC-listed stock may have a higher chance to double or triple in the next couple of months than a large-cap stock like GW Pharmaceuticals. However, these types of stocks also have a much higher risk of downside and can be an unnecessary risk within an already extremely volatile market segment.

Selling too early.

Canopy Growth reached $52 per share in April, a gain of more than 90% for the year. After such rapid growth it may seem like a good time to sell and move on. However, Grand View Research has projected that the legal marijuana market will grow to $146.4 billion by 2025 and continue to expand in the longer term. Canopy Growth shares have made some major gains in 2019. But remember, investors who sold Netflix (NFLX) stock in May 2010 after a quick 60% missed out on nearly a decade of subsequent market-leading returns.

Not preparing for headline risk.

At the end of the day, marijuana is a drug. Due to its federal ban in the U.S., researchers have only been aggressively studying the potential benefits and risks of the drug for a limited window of time. While this additional research in the years ahead could certainly uncover some wonderful medical benefits to marijuana use, it could also unearth some unforeseen side effects. Depending on the severity of these side effects, the long-term outlook for the cannabis business may not be impacted significantly. But negative health headlines could do a lot of damage to investor sentiment and share prices.

Assuming the economy will continue to grow.

Most cannabis investors believe the global growth phase of the marijuana industry is still in its infancy. Canadian suppliers are already having a difficult time producing enough cannabis to supply the Canadian market, much less the U.S. and the rest of the world. To expand their business, they need capital to invest in acreage, infrastructure and staff. In today’s economy, that capital has been easy to come by via loans, equity offerings and outside investments and partnerships. However, when the next economic downturn inevitably comes, those sources of capital could tighten or even dry up completely in the short term.

Believing all marijuana stocks will be winners.

The cannabis stock bull case hinges on the idea that in the long term, global bans on marijuana will be lifted and consumers will open up to cannabis consumption. But even if the marijuana business is ultimately a big winner, it doesn’t mean all marijuana stocks will be too. Apple (AAPL) investors know that the smartphone was one of the most profitable and successful products of all time. However, shares of BlackBerry (BB), an early leader in smartphones, are down 87% in the past decade. For every cannabis version of Apple, there will surely be dozens of BlackBerrys.

Trying to time the market.

One way to turn a winning stock into a loser is to try to day trade and time near-term swings in the market. Responsible investing is a marathon, not a sprint. The average daily gain for the S&P 500 in 2019 is just 0.19%, yet it is up 19% year to-date. Cannabis investors who are getting bored with small day-to-day fluctuations in share price should resist the temptation to take a more active trading approach. As many as 95% of day traders ultimately end up losing money on their strategies, according to Vantage Point Trading.

Investing in companies without unique products.

Given current cannabis producers are having a difficult time keeping up with booming demand, most companies are having no problem selling their products. However, as the market balances out over time, the ultimate winners will be companies with leading brands and differentiated products. Investors, partners and customers will gravitate toward high-quality and unique products. Like any other business, companies that cannot defend their market share will struggle to keep up and risk being left behind in the long term. When researching cannabis companies, pay close attention to any special attributes that sets the company apart from its competitors.

Ignoring valuations.

Investors have a difficult task in determining appropriate valuations for cannabis stocks given the large degree of uncertainty in their long-term outlooks. Using today’s numbers alone, the current valuations of many of the leading cannabis stocks seem astronomically high. However, these companies are still in the extreme growth phases of their businesses, and most are priced based on long-term financial projections. These valuations may ultimately prove justified if the cards fall in place for the cannabis industry. But investors should understand that it may take several years for many of these businesses to grow into their current valuations.

Common mistakes when investing in marijuana stocks.

Not enough diversification.Assuming online information is reliable.Not researching carefully.Believing U.S. federal regulation will be quick.Not understanding the regulations.Focusing on high-risk stocks.Selling too early.Not preparing for headline risk.Assuming the economy will continue to grow.Believing all marijuana stocks will be winners.Trying to time the market.Investing in companies without unique products.Ignoring valuations.1 of 16

Wayne Duggan, Contributor

Wayne Duggan has been a U.S. News & World Report contributor since 2016. He is an expert at ...  Read more

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