What you need to know to recognize great opportunities at a glance.
The global marijuana market is gathering momentum as an increasing number of states and countries are shifting their views on it. Over 32 states allow it medically, and at least 10 allow its use recreationally, with a number of other states looking to join the list.
These states are seeing higher tax revenues as it occurs, and can redirect law enforcement funds to higher priorities. With this trend underway, here are five tips to finding the best investment opportunities:
Tip #1: Know which type of marijuana stock you’re buying. The marijuana space as a whole has a variety of working parts, due to the number of different products available.
Investors have options that generally include cannabis growers, who directly cultivate marijuana, harvest the crops, and sell their end product, either to distributers or directly to customers.
The second category of marijuana stock are the biotechs, which focus on developing cannaboid-derived drugs. They may not be as profitable right now, but they have the potential to add innovation to the space.
Finally, there are providers of ancillary services such as packaging, transportation, hydroponics and lighting, and other agricultural equipment. This space may not be a pure-play on the space, but some diversification here may help take the sting out of one of the periodic bear markets in the cannabis space.
Tip #2: Understand the risks going in. Besides the broad differences between types of companies, each company has its specific risks. One marijuana cultivator may work under conditions that limit the quality and quantity of what it can grow that others don’t.
Besides those company-specific risks, there still remain considerable regulatory hurdles between state and federal agencies. While the federal government is slowly moving towards decriminalization of marijuana, there remains some conflict between the feds and state governments that have created a number of impediments that may impact any investment you make in the space.
Finally, the space has a number of companies that trade over-the-counter (OTC). Typically, these stocks are known as penny stocks, as they trade under $5 per share. That doesn’t mean they’re bad companies!
However, it can mean that if you buy a lot of these shares simply because they’re cheap, you may have trouble finding the liquidity you need when you need to get out of the trade and sell those shares. That’s another risk factor that can often get overlooked in fast-growing industries like this one.
Tip #3: Know what to look for before investing. Besides a company’s specific qualities that differentiate it from investors, before you start to invest, it’s important to consider some other factors as well. One factor might be to look at some specific technical indicators to determine if a company is overbought or oversold in terms of its relative strength index.
Buying oversold companies and taking some profits off of overbought companies ensures that your trades are more likely to be profitable. At the very least, avoiding a potential investment that may go down can save you from a few losses, which also helps your overall returns on the trades that do work out.
Tip #4: Keep an eye out for changing industry trends. Sometimes, the market tends to extrapolate the legalization and adaptation of marijuana and cannaboid products at a faster pace than is likely. This optimism in the market then creates a glut in supply and lowers prices—and reduces profitability for the space as a whole.
These business cycles occur in all industries, but for a fast-growing one, it can mean that an overleveraged company that was a great investment during a bull market is a possible bankruptcy candidate during a pullback.
While the long-term trend is upwards, remember that no trend moves in a straight line!
Tip #5: Know your limits and invest carefully. Investments in the marijuana space have a high growth potential, but also carry industry-specific risks. While some of those may go away in time, overinvesting in the space or investing at high prices could result in low returns.
Provided you’ve done your homework, putting a limit on what you’re buying and how much you’re willing to pay per share—no matter how attractive future opportunities look—can prevent you from overinvesting, or putting too much capital into any one marijuana trade that may subject you to company-specific risk.
While it may mean leaving some profits on the table, it’ll also provide you with the best overall way to ensure you make an overall profit, even if some trades don’t work out.