Changing news cycle and future valuation point to buying opportunity now.
Investing can often come down to cycles. Most assets move in them, swinging between being in favor with the market and becoming overbought, or swinging out of favor and becoming oversold.
Right now, cannabis stocks are still out of favor with the market. They’ll swing back in favor in time, but a few short-term fears are weighing on the price. However, there are some early indications that the turn is starting.
It may be time to add to your preferred holdings in the space as a result. There are two main factors at play right now that give us a hint that the sector is turning around.
Oversold Factor #1: Resolution of Vaping Fears
One of the biggest problems with cannabis has had to do with vaping-related illnesses and deaths this year. That’s sent the e-cigarette business slowing as well. So far this year, over 2,000 have had some kind of health challenge in just about every state—and with about 40 deaths this year from vaping-related products, which in turn has turned off potential customers in the cannabis space.
However, federal researchers announced last week that a toxin likely responsible for the problem has been identified. And many industry players in the vaping space have started to crack down on third-party products which may have been modified at a risk to the health of others.
These fears are real, palpable, and can impact a company greatly. But they can also turn around in time as the issues get resolved. Similar issues occurred with tampered aspirin bottles in the early 1980’s, which led Johnson & Johnson (JNJ) to create tamper-proof bottles, which in turn became the industry standard.
And more recently, Chipotle Mexican Grill (CMG) had some e-coli related health scares in some of its restaurants from contaminated lettuce that led to a short-term drop in shares, but allowed the company to address the health concerns in a way that addressed the issue while also protecting its reputation and supply chain for delivering fresh ingredients to customers.
This is a short-term fear that, while dire at the moment, will tend to fade in time. More importantly, companies that rise to the occasion and create a better and safer customer experience as a result, tend to do well for investors over time.
Oversold Factor #2: Political Delays in Cannabis Rollouts
Many investors in the cannabis space expected a quick moonshot. And while many stocks in the space rose quickly, the fact of the matter is, it really does take time in any industry to build a great brand and reputation. Much like how Google’s (GOOG) dominance of the search engine space didn’t come about until after a number of other competitors had developed their products, we still don’t yet know which company in the space will become the preferred go-to for customers.
In the meantime, many states that embraced legalization of cannabis use have succumbed to political factors that have resulted in the delay of a fast rollout that many investors were expecting. California, for instance, set a tax on cannabis products that expected to bring in $1 billion in revenue to the state. Instead, because the tax is so high, it’s keeping legal cannabis competitive in price with black-market goods—and when push comes to shove, people prefer to pay the least amount of taxes possible.
In Illinois, a law regulating the number of stores that can be owned by a single company to 10 is impeding a rollout. As a result of this rollout, Illinois will only be able to field less than 4 stores per 100,000 residents, less than half that of Colorado and less than a third that of California. Illinois is the only state whose legislature legalized cannabis without going directly to the public with a referendum or other direct vote.
And, of course, even with these state restrictions, Congress only recently changed the law allowing these companies better access to traditional banking systems.
In short, we have some short-term product fears that have historically made an industry stronger along the way. And we have some political issues that are slowing down the prospect of rapid gains.
But the direction is still right for patient, long-term cannabis investors to add to their stakes now. With shares of many of these companies so beaten down, it may be time to add to a stake now. As a result of the many big, but well-known issues currently being dealt with, the move from having a flurry of bad news to simply having less bad-news could cause a sharp rally in a short amount of time.
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