Story by Jeff Gee
Nearly two years ago the Security and Exchange Commission (SEC) issued a press release cautioning investors about investing in cannabis related micro cap stocks. This warning came at a time when a tremendous number of cannabis stocks were exploding with huge run ups from their 2012-2013 lows and subsequently tanking right back to where many started.
It was like a microcosm of the tech stock bubble of the late 1990s. Cannabis stocks would go from pennies on the dollar to over $100, hang out there for a few weeks or months, then find themselves back where they began. This put a new meaning into feeling the burn (not Bern!).
Much of the driver for cannabis stock valuation revolves around regulations and law. Not unlike what we see in the major indices worldwide, when news hits, it affects stocks even if news itself has nothing to do with a particular company or its ability to execute. With 2016 shaping up to becoming a very busy year for cannabis regulation, expect this year to contain high risk on the up and down side.
Raising capital to grow a business is quite normal in our economy. But with banks unwilling or incapable of providing credit, astute business owners will seek a variety of venues to gain access to capital. One particular avenue is by selling shares. Incorporating a business and selling shares is a socially acceptable practice and will continue to be for decades to come.
For the cannabis related companies, the market of choice is the OTC. The acronym at one point may have stood for Over-The-Counter, but the OTC Marketing Group, the owner of the exchange, has a different tag line: Open, Transparent, Connected.
The OTC has a long history in providing a forum for investors in the United States. In the US, it is one of the easiest and simplest markets to bring a company into. This in itself makes it quite risky. There are three grades in the OTC: OTCQX, OTCQB and OCTPink. Each grade represents a degree of quality and confidence. OTCPink is the lowest and has the least amount of quality or confidence. This is where cannabis products trade.
Trading in the ‘Pink Sheets’ isn’t necessarily a bad thing nor does it mean that all companies trading there are dubious. What it does mean is that the amount of information that a company provides its investors may very well be limited at best. In fact, an investor may never see a real balance sheet. It is up to the individual investor to perform a level of due diligence with respect to a company’s financials, products and growth. What does this mean? Well, simple things like is there a web site? If so, is there a product or service? Does this product or service seem real? Is there someone to call? If so, pick up the phone and call. What to ask? Experienced investors will know what questions to ask. And this is why this market is probably best left to experienced investors.
On the other hand, there are dubious companies. Without naming names, there are companies that simply release press statements. They may or may not have any product or relevant service. They may only be staffed by 1 or 2 individuals. Policing these companies falls to the individual investor. Many are just riding the coattails of the cannabis wave. Therein lies the risk. Business, or individuals masquerading as a business, that has limited to no staff, limited or sparsely detailed financials, no real product or seemingly insignificant or irrelevant products are subject to caution to say the least.
But this isn’t everyone. There are companies run by professionals who want to grow their business and increase their value to their investors.
To help with some of this, we tap Alan Brochstein of New Cannabis Ventures and founder of the 420 Investor. Alan has been covering the cannabis stock scene for a number of years and has been known for his critical take on this volatile market.
CBJ: What happened in 2014?
AB: There were few stocks that people could buy, but many people who wanted to buy them. Everyone was trying to squeeze into one place. Most of the stocks were terrible stocks and we shouldn’t envision this kind of rally in the future.
CBJ: What advice would you give to novices?
AB: Like edibles, start small and go slowly. You don’t need to do it all at once. Don’t treat it as a once in a lifetime investment. Do your research. Did they [the company] file with the SEC? If so, this is not necessarily a green light, it is just not a red light.
Is there a real office? Who is running the company? Do they have cannabis experience? Do they only have cannabis experience? What are their experience and skills? Does their business plan make sense, what is their debt load? These are all questions to ask when investing in OTC traded businesses.
Be aware of press releases. These are the edge of the truth. Always ask questions and inquire within.
CBJ: Are there any funds, ETF like products or professionals out there to help investors who don’t have the time or skill set to work the trading market?
AB: Unfortunately, the liquidity isn’t there, so nothing exists yet. Canada is much closer to this with the cannabis stocks that are being traded there.
CBJ: How would you suggest investors manage risk in this sector?
AB: Limit the amount you are willing to lose. Remember, we’re not yet at the point where we’re investing vs. trading. I’ve heard of people investing in all of the stocks at once. That’s crazy. Over diversifying like this isn’t a good idea; essentially don’t put a lot of rotten eggs in one basket. So many of these companies are speculative investments that a little research goes a long way.
CBJ: Finally, what are your thoughts on investing in the future?
AB: The OTC stigma is going away. So this is a viable marketplace. We’ve seen a couple of firms like Terra Tech and Mass Roots look to trade on the NASDAQ. This is a good sign.
There may be a lot of churn this year because of the measures on state ballots and statements coming from federal agencies.
Buying and holding isn’t a really good strategy with these stocks. Today, this is a trading market.