The Highs and Lows of the Budding Marijuana Stock Market

Along with legal weed comes an emergent market for shares in pot-related businesses.

Amateur investors are known to get high on hype. And as 2014 rolled in, they were presented an unusually appropriate source for it.

For years, companies tied to the marijuana industry have been trading on the over-the-counter (OTC) market—home to so-called “penny stocks,” where listing standards are almost nonexistent and stock prices can fluctuate drastically day by day.

Investors could buy shares in companies like MedBox, which sells fingerprint-activated “weed safes” to retailers. Then there was Advanced Cannabis Solutions, which connects ganja growers with land leases, and Growlife, which sells them growing equipment. The list stretched on.

These “pot stocks” mostly flew under the radar until this past January, when the nation’s attention shifted to Colorado for the opening of the country’s first recreational weed stores. Almost instantly, pot stocks that had spent December scraping 52-week lows were skyrocketing, sometimes ascending over a thousand percentage points.

Most of these stocks have since sunk back to roughly their previous levels. What had occurred was obvious: Rookie investors saw reports of jam-packed stores in Colorado, decided weed businesses were a fast track to riches, and threw money at pot stocks like they were going out of style (which many quickly did).

Coverage of this surge has mostly presented it as a cautionary tale or played it for laughs. Day-traders must have been stoned to invest in some of these companies, pundits said, and reasonable people should stay far away from weed-related investing for a few years until the market’s established.

However, recreational weed shops will soon opening in Washington state; legislation is before Congress to ease relations between bankers and pot businesses; and Bloomberg Industries estimates legal weed could yield $35 billion to $45 billion in sales annually.

Is there really no reason to be bullish on pot stocks right now? Did the first pot-stock “bubble” yield no more useful lesson than “stay away”?

Under the roof of Seattle’s prestigious Washington Athletic Club, dozens of respected investors gathered in January 2013 for a business conference that a decade earlier would’ve been unimaginable. The subject was pot, and the company was mainstream: Then-mayor Mike McGinn gave a speech and a reporter documented the proceedings for a Fortune cover story. The meeting’s purpose: for potential investors to hear pitches from pot-focused companies.

“For many investors, the end of canabbis prohibition is no longer a question,” says Troy Dayton, CEO of angel-investor network Arcview Group and organizer of the meeting. “When you see the President and possible Republican candidates [for president] trying to beat each other to the punch to sound reasonable on pot, when you see legalization’s [favorable] poll numbers jump 10 points in a single year, prohibition doesn’t have a long-term future.”

Skeptical of most pot stocks, Dayton says the best investment opportunities remain in private companies—for example, Seattle-based Privateer Holdings, which raised over $7 million last summer to acquire pot companies and counts a former DEA agent among its management. Privateer Holdings’ most prominent acquisition so far has been Leafly, a Yelp-style online review service for dispensaries and weed strains.

“The stocks out there aren’t bad, some of them, but it’s dicey investing overall,” Dayton says. “It’s important to do your homework.”

Someone doing a lot of that homework is Alan Brochstein, an investment consultant since 1986 and columnist for respected investor website Seeking Alpha. Last year Brochstein launched 420 Investor, a professional, for-pay newsletter advising investors on the opportunities and land mines of the pot-stock market.

Brochstein spends an inordinate amount of time analyzing every pot stock he can find, of which he counts 42 currently. Only a small percentage of those companies have solid prospects for success, he says, but that’s normal in a budding industry.

“I was on Fox Business Channel recently, and it’s funny, because they really misrepresented me,” Brochstein says. “I was trying to give a balanced view of the market, and they ran it under the tagline ‘Pot Stocks are Bad’ . . . That’s the easier narrative, I guess.” As he sees it, the market of pot stocks “isn’t really an investor’s market right now. I wouldn’t advise Granny to enter it. . . . This is a trader’s market, for people who keep an eye on things and do their due diligence. If you trade right, there’s real returns to be had.”

Only two pot-related stocks are currently listed on the NASDAQ: GW Pharma, a biotech company focused on cannabinoid products and partnered with industry players like Bayer, and Full Circle Capitol, which invested millions in Colorado's Advanced Cannabis Solutions recently. But the rest, Brochstein says, are on the over-the-counter market.

If playing the stock market is like gambling, the New York Stock Exchange is Caesar’s Palace—full of dealers operating under specific guidelines and gamblers who know what they’re doing. The OTC market, by contrast, is an underground boxing match in Bangkok—a borderline-lawless atmosphere and plenty of sketchy characters, and the people walking out with the most money are usually fixers.

Robert McVay is a lawyer at CannaLaw Group, a Seattle-based firm that specializes in marijuana-related cases. He gets calls all the time from people who bought shares in a pot-related company only to find it was millions in debt or existed simply to separate suckers from their money.

“Just because a company’s listed ‘over-the-counter,’ it doesn’t mean they’re up to no good,” he says. “They could be doing it to get funding, and to get an idea of their market valuation. The problem is this is a new and exciting market for people, and there’s lots of new investors without much history. They make bad choices.”

More bad choices are to come, most likely. 2014 will be the year of pot-stock bubbles, in Brochstein and Dayton’s estimation. The next will come when Washington state opens its recreational-weed stores, currently scheduled for this summer. As CNN cameras flock to Seattle’s 21 new marijuana stores, another wave of hype will hit.

In November, when more states vote on both medical- and recreational-marijuana laws, another horde of amateur investors could enter the market. But these booms and busts are just growing pains, Dayton says.

As the business of pot becomes more legitimate, so will the people involved. It’s currently illegal for a bank or credit union to deal with a marijuana grower or retailer. Everything is done in cash. Legislation recently co-sponsored by Washington state congressman Denny Heck would change that, and could open the floodgates to big investments, weed-related business plans that are on the level, and stocks with real futures, even on the OTC market.

“You’re going to see a lot more publicly traded companies in the next year or two, and more and more, it seems the new stocks are doing business the right way,” Brochstein argues. “This is the beginning of something huge, right now. And there’s something to be said for getting in on the ground floor, if you do it smart.”

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