Cannabis stocks are down sharply ever since the group got its best news in decades – President Donald Trump’s December 18 executive order to reschedule the plant.
Using the AdvisorShares Pure U.S. Cannabis exchange-traded fund (MSOS) as a proxy, the group is off 32%.
That makes the sector a strong buy, in my view, for the following seven reasons.
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7 Reasons Cannabis Stocks Are a Strong Buy
1) It’s a contrarian play.
Online cannabis trading pundits on social media were befuddled and bewildered by the sharp move down on the great December 18 rescheduling news.
But the sell-off was really entirely predictable, because it was just the stock market confirming a long-standing market axiom: the Greater Fool Theory.
I’m not stating that it is foolish to invest in cannabis – quite the contrary. Instead, the Greater Fool Theory describes the mentality of anyone who buys a 50% up move in a group, thinking it will move higher because of expected news that is already widely anticipated and priced in.
These punters are not investing or even trading. They are simply betting they will be able to find a Greater Fool to take their shares when the already-priced-in news hits.
The minute it becomes apparent there are no Greater Fools to sell to – after the expected news hits – all of these speculators panic and sell hard. That creates a downward spiral in the affected asset class, like we saw in cannabis on the rescheduling news.
The severe damage also creates a lot of haters and negative emotion towards the group. Unfounded and false conspiracy theories of “manipulation” or flaws in how popular cannabis ETFs are created (through swaps) run rife. All of this creates a negative sentiment dynamic that is eminently buyable, in the contrarian sense. That’s where cannabis is right now.
2) There’s another big catalyst just around the corner.
President Trump ordered Attorney General Pam Bondi to issue a rescheduling rule expeditiously. No one knows exactly what that means, but widespread reporting citing sources inside the White House suggests it means inside January. The rescheduling order will once again draw a lot of attention to the group, attracting buyers and creating another rally. Like the executive order rally, that will be a sellable rally for traders. For long-term investors, it will just be more volatility to live through.
3) The rescheduling news is really awesome.
Rescheduling means moving cannabis to Schedule III from Schedule I under the Controlled Substances Act. This helps cannabis companies immensely by neutralizing an IRS provision (Rule 280E) that bars the deduction of operating expenses against revenue from the sale of Schedule I substances. This is not a “tax break” as cannabis opponents claim.
Instead, cannabis companies that have historically paid an impossibly punishing 70% tax rate will soon be on a more even playing field with all other companies, which pay tax rates more in the 0% to 20% range. Their free cash flow will surge dramatically. Problematic debt loads and interest rates become less of an issue. They’ll have more money to invest in growth or to fund share buybacks. Yes, there are buybacks in the troubled cannabis sector. Exhibit A: The financially conservative Green Thumb Industries (GTBIF), for example.
4) Rescheduling will have broader positive effects.
“You can’t ignore the sentiment impact that this has just in terms of getting people interested in the business and realizing there is a great market opportunity here, and opening up other sources of capital for the industry and other avenues for exploring growth,” Organigram Global (OGI) CFO Greg Guyatt recently noted in a media interview.
He’s right. It is all part of what I have been describing as a “cultural momentum” towards cannabis reform. We see this in opinion polls consistently reporting majorities of voters favor some form of legalization, robust and ongoing cannabis sales growth in Heartland states, broader consumer substitution of cannabis for alcohol (for better or worse), and high-profile sports leagues removing cannabis from the lists of forbidden substances they test for.
On a practical level for investors, this cultural momentum increases the odds that states like Pennsylvania, Virginia, and Florida will soon legalize recreational-use sales, and that Southern states like Tennessee and others will join Kentucky in making cannabis sales legal in some form. This cultural shift in the South is important because Southern states have been the holdouts on cannabis reform. There may also be progress on important changes for cannabis companies, like descheduling, reform that creates greater access to banking, and uplisting to major exchanges.
5) Hemp is off the table as a competitor.
Recent federal reform essentially banning hemp-derived THC products takes this cannabis company competitor for consumer dollars off the table.
6) CBD is on the table.
The Trump administration wants to have Medicare reimburse the cost of CBD products used in healthcare. Since cannabis companies know about growing the plant, if they know about anything, many will likely branch out into CBD production, assuming it looks like the Medicare reimbursement is real and sustainable.
7) Legal challenges to rescheduling face an uphill battle.
Long-standing cannabis opponents will no doubt launch legal challenges to rescheduling once Bondi and the Department of Justice issue a final rule. They probably won’t get anywhere, attorney and administrative law expert Shane Pennington of the law firm Blank Rome tells me. “Those challenges will fail because the parties seeking review likely won’t have standing or even if they do, they’ll have no argument to show the final rule is unlawful,” he says. We won’t really know until we see their arguments, he notes. But that’s his high-level takeaway at the moment.
Despite the long odds of success, news of the lawsuits may create a buyable dip in the group. For some of the best cannabis-related names to own, including relatively safe (and now safer) income plays yielding 12% or more, as well as biotech stocks that may benefit from rescheduling (one of my biotech suggestions advanced 105% on a buyout, another is already up 36% since I suggested it in late October) consider subscribing to Cabot Cannabis Investor here.
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