Why Marijuana ETFs Won’t Make You Money – But These Stocks Will
Most retail investors are perfectly happy using ETFs as a way to manage their costs and their risks. But if you’re considering investing in the cannabis sector, using an ETF has not been a good strategy (yet).
Most retail investors are perfectly happy using ETFs as a way to manage their costs and their risks. If you’re interested in a particular sector or asset class you can easily get exposure to that in your portfolio with a single low-cost trade.
Plus, ETFs boast low expense ratios as compared to a professional investment manager and most online brokerages now offer commission-free trading. And, if you’re invested in an ETF that focuses on commodities, for instance, failure of a single company owned by the fund, or even a sharp dropoff in their share price, is unlikely to make a material impact on your investment.
You can take comfort in avoiding big losers at the cost of probably having any big winners. But if you’re considering investing in the cannabis sector, using an ETF has not been a good strategy (yet).
Just take a look at the table below, which shows the results of the biggest six cannabis ETFs since their launch dates compared to the results of my advisory over the same period. (The first ETF, MJ, was launched in December 2015, before Cabot Marijuana Investor was in existence, so I’ve moved its start date up to the time of this service’s launch—but for the record, that ETF is down 50% since inception.)
|Name||Start Date||ETF Change||CMI Change|
|MJ||Alternative Harvest ETF||8/18/17||-63%||259%|
|YOLO||AdvisorShares Pure Cannabis ETF||4/19/19||-47%||-7%|
|THCX||The Cannabis ETF||7/12/19||-61%||7%|
|CNBS||Amplify Seymour Cannabis ETF||7/26/19||-40%||17%|
|POTX||Global X Cannabis ETF||9/20/19||-74%||29%|
|MSOS||AdvisorShares Pure U.S. Cannabis||9/2/20||7%||39%|
Bottom line, holding any of these cannabis ETFs has been a terrible way to make money. In fact, it’s been a great way to lose money.
Why Cannabis ETFs Lose Money
And why is that? Three reasons.
First, it’s because these ETFs hold a wide variety of stocks in the sector, and a lot of the smaller companies in the industry have been failing as their bigger, better-funded, better-managed competitors gradually increase market share.
Second, it’s because this sector is prone to extremes of investor behavior. The money gushes in when the stocks have been hot for a while, but it gets withdrawn when the stocks have been cold for a while, and this has the effect of forcing the manager of the ETF (even those that are passively managed) to buy high and sell low.
Third (though significantly less important), most of these ETFs are small, so they don’t have the economies of scale that work for larger ETFs.
Now, this is not to say that holding the individual stocks has been a picnic. As investors who stuck with the sector through 2021 know, after peaking in February, cannabis stocks trended steadily downward for the rest of the year, as hopes that the new Democratic leadership in Washington would move forward on federal legalization of cannabis gradually faded.
But the odds are now very good that 2022 will be a great year for investors in cannabis stocks—mainly because this selling has gone on long enough, but also because the fundamentals of the industry are great for the biggest companies, which are growing increasingly efficient, and because eventually, federal legalization will be achieved. So as the trend turns up, my goal is to ensure that my readers are in the stocks leading the way!
How I Pick Cannabis Stocks
Here’s how I do it—and how I’ve managed to beat the index every year since I launched Cabot Marijuana Investor in 2017.
I look at size, because bigger companies are generally efficient in fast-growing industries.
I look at the rate of revenue growth, because fast growth makes almost everything easier for management.
I look at profit margins, which are a great indicator of management’s capabilities.
I look at the stocks’ valuations, because while there are no true cheap stocks in a hot industry like this, where all the stocks are overvalued by typical measures, there are still relatively good valuations.
I look at the stocks’ charts, because the charts reflect everything that investors know and expect about the stocks, and the strongest stocks are your best route to profits.
I recommend a handful of peripheral companies in the sector, companies that are not “plant-touching” and thus are totally legal federally and therefore attractive to institutional investors.
In 2021, we had great success with Innovative Industrial Properties (IIPR), a REIT that serves as landlord to many cannabis companies who are unable to get traditional financing because of federal illegality. And in 2020 we did well with GrowGeneration, (GRWG), a Colorado company that’s become the country’s largest seller of hydroponic gardening supplies by targeting commercial cannabis growers and by growing rapidly through acquisition.
Finally, I pay attention to market timing, telling my readers to pile into cannabis stocks when they’re down and cheap—and telling them to take profits and hold cash when the sector goes into a parabolic top, as it did in February 2021; I told my readers to sell half their cannabis stocks on the very top day.
But today I’m not thinking of selling, I’m thinking of buying, because the best companies in the sector saw their stocks bottom in December, and as January gets rolling, I’m seeing increasing signs that the new uptrend has started. Just remember, if you want to make profits by investing in the cannabis sector, don’t buy the ETFs, buy the stocks.
Do you own any cannabis ETFs or individual stocks? If so, which ones? Tell us about them in the comments below.