Risk and Riches: The Marijuana Gold Rush Is On

Right now, the marijuana industry is tripping through its own version of a gold rush. Entrepreneurs are racing to build businesses that will weather the storm and investors are scrambling to get their hands on equity while it’s still cheap. Each group is trying to capitalize on the advantages available to early movers while dodging the various legal pitfalls of the marijuana gray market. Like any good gold rush, it’s a high-risk, high-reward scenario.

The evidence is in the price action of marijuana industry stocks. Most trade over-the-counter and for fractions of a dollar and fall under the dubious umbrella of penny stocks. In August of 2013, the Financial Industry Regulatory Authority (FINRA) issued an alert to investors warning them about potential scams associated with marijuana-related stocks. Specifically, FINRA warned about the well-known ‘pump-and-dump’ scheme in which, “fraudsters lure investors with aggressive, optimistic — and potentially false and misleading — statements or information designed to create unwarranted demand for shares of a small, thinly traded company with little or no history of financial success (the pump.) Once share prices and volumes reach a peak, the cons behind the scam sell off their shares at a profit, leaving investors with worthless stock (the dump.)”

The weight of this warning became tangible in January 2014 when marijuana industry stocks surged anywhere from 20 to 1,700 percent. There were a number of catalyst behind the surge, but the primary one was the implementation of recreational marijuana laws in Colorado. From here, the the frenzy was inevitable.

Businesses have been positioning themselves for years, each trying to be a leader in an industry that is expected to be worth billions of dollars in the coming years. Marijuana sales reportedly averaged about $1 million per day in the first five days of legalization in Colorado, and policymakers are expecting full-year 2014 sales of about $600 million. The market in Washington state, which is expected to legalize the retail sale of weed this year, is projected to be at least as large, if not larger. One study cited by the Huffington Post predicts a $10 billion market in the U.S. by 2018.

As the story usually goes with pies, everybody wants a piece (THC, the primary psychoactive ingredient in weed, is fat soluble, so don’t categorically rule out marijuana pastries.) The challenge that investors face is to pick the good pieces from the bad, and they have to do it in a frenetic jungle of incomplete information and hype, or on some days, misinformation and speculation.

It’s probably wisest for most investors to simply avoid marijuana stocks — in fact, it’s probably wisest for most investors to simply avoid penny stocks all together. Investors who do tempt fate and look for a winner in the marijuana industry right now should be certain that their stomachs can handle their appetite for risk. Especially right now when marijuana-industry stock prices are elevated well above where they were even just six months ago, would-be investors should tread carefully.

But that being said, it’s hard to ignore the siren’s call of a budding industry. Many marijuana businesses are becoming more legitimate by the day and the regulatory fog of war is dissipating. There is money to be made in marijuana, but as always, the question is: is the investment worth the risk?

If you were to follow the advice of Berkshire Hathaway Chair and CEO Warren Buffett, the answer might be no. “Keep things simple and don’t swing for the fences,” Buffett wrote in his 2013 letter to shareholders. “When promised quick profits, respond with a quick ‘no.’” Investors interested in value may also balk at the currently inflated prices for shares of marijuana businesses, which is fair.

But there’s still an argument to be made for the long-term investor willing to sink some money into a high-risk play. If an investor believes that the marijuana industry will become an institution in the U.S., as ingrained as alcohol or prescription medicine — remember, it’s not all recreational, there’s a robust medical market for marijuana — then why not buy into companies that look poised to capitalize on the evolution of the market?

Just make sure to exercise good decision making if you walk down this road. Look for businesses with a track record that are productive, and look for businesses that have strong management. Just because the market is volatile doesn’t mean an investor should jump in and out of a position, trying to take advantage of price swings. Think long.

The field of possible investment candidates in the marijuana industry is pretty broad, but there are a few large players that come up again and again the conversation surrounding the place. Here’s a quick look at a couple of them.

Medical Marijuana Inc. (MJNA.PK)

In some ways, Medical Marijuana Inc. is a “one size fits all” investment choice. The company is comprised of a self-described “diversified portfolio of products, services, technology, and businesses solely focused on the cannabis and hemp industries.” The company’s portfolio includes companies such as CanChew, which makes cannabinoid-based gum; PhytoSPHERE Systems, which builds and develops growing, packaging, and extraction technology; and KannaLife Sciences, which is involved in research and development of new therapeutic uses for marijuana.

Medical Marijuana Inc. is the largest and arguably most well-established company in the space. The company has traded stock on the OTC markets since April of 2009 from which shares are currently down about 48 percent at 29.5 cents a piece (market cap of $279.54 million.)

It is important to highlight the fact that Medical Marijuana Inc. is not fully reporting, so we don’t really know as much about it as we would like. The company does provide “quarterly highlights” to fulfill disclosure requirements under Rule 15c2-11 of the Securities Exchange Act, which basically states that the company needs to make available a prescribed set of information about itself. The most-recent disclosure is for the quarter ended September 30, 2013.

Cannabis Science, Inc. (BB:CBIS.PK)

Cannabis Science looks like a company with its heart in the right place, but it is perhaps not the best investment choice. The company is led by Dr. Robert Melamede, who is a fairly renowned cannabinoid research scientist, and (broadly speaking) his company’s goal is to pursue the development of cannabinoid-based medicines and get them approved by the U.S. Food and Drug Administration.

For those who believe in the medicinal power of cannabis, this is a great thing. For those who are looking for a great investment — not so much. The company does report with the SEC, which is a huge plus, but what it has had to report is pretty unattractive. For the quarter ended September 30, the most recent for which there is data, Cannabis Science reported revenue of $70,581, up from $1,848 in the year-ago period, but the revenue is saddled with a net operating loss of over $1 million. The company had more than half a million dollars in general and administrative costs for the quarter. Cannabis Science has reduced its year-to-date net loss to $3.9 million from $14.1 million, but it’s hard to get excited about the improvement.

The company has a pretty big liquidity problem. The 10-Q states that, “There are insufficient liquid assets to meet current liabilities or sustain operations through 2013 and beyond and the Company must raise additional capital to cover the working capital deficit. Management is working on plans to raise additional capital through private placements and lending facilities. The company currently is relying on continuing loans from stockholders to meet its obligations and sustain operations.”

Hemp, Inc. (HEMP.PK)

Hemp populates this list mostly because there is generally an enormous amount of confusion about what this company actually does. Hemp, Inc., makes hemp products, not marijuana products. The company was careful to explain the distinction between the two in July 2013.

“Hemp, Inc. focuses strictly on Industrial Hemp products,” the company wrote. “The major market for Hemp is as a food or supplement as it is rich in protein, Omega fatty acids, and has a high fiber content. Costco carries hemp seeds, and Natural Grocers and Whole Foods Market stock many brands of Hemp food products and supplements. The clothing industry has targeted Hemp as a provocative niche market fabric. High fashion designers Ralph Lauren and Versace make apparel from Hemp blended fabric. Footwear giants Vans and Adidas make Hemp sneakers. Trendy companies market hemp T-shirts, hats, jewelry, backpacks, even pet beds and leashes. Auto manufacturers use durable, green Hemp composites and fabrics when feasible. Industrial Hemp can also be used for building materials, plant based plastics, and paper products.”

So Hemp, Inc. may very well be a solid investment candidate, but it is not really a marijuana stock. However, the legalization of hemp cultivation is caught up in the marijuana legalization movement, so the fate of the two industries overlap. Hemp, Inc. also owns Marijuana, Inc., which also appears to primarily be a company involved in hemp products.

Growlife, Inc. (BB:PHOT.PK)

It’s no secret that when the gold rush is on, the person in the best position is the guy making the picks and shovels. Much of the pessimism that surrounds marijuana-industry penny stocks is the severe competition. Most people who set out to strike it rich looking for gold will never find any, and not every company with a foot in the door of the medical or recreational marijuana industry will succeed. But everybody — those who fail and those who win — will be buying the equipment necessary to compete.

Growlife is one of the companies selling those picks and shovels to the marijuana industry right now. Through brands like Stealth Grow LED, SGsensors, and Phototron, the company is engaged in the business of providing would-be marijuana growers with the tools they need to thrive. This equipment falls under the umbrella of the urban gardening industry. The company operates both retail locations and an online storefront.

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