Which Cannabis Stocks Will Light Up the Market?

SMITH BRAIN TRUST — Pot may be tantalizing investors, but publicly traded cannabis companies remain risky. States legalizing marijuana for medicinal and recreational use have been multiplying in recent years. And sales are projected to rise to just under $23 billion by 2020, from $6.7 billion last year. But even as U.S. cannabis firms anticipate growth, regulation remains a big uncertainty, according to University of Maryland Robert H. Smith School of Business grad Evan Qiu (Master of Finance '16) and Quantum Financial Advisors co-analysts Peng Zhang and Steven Nunez, a 2010 UMD economics graduate.

"The team fleshed out the risks and best bets in a new white paper because cannabis may be the next, and only, growth sector for the next decade," says adjunct finance professor and Quantum CEO Joe Rinaldi. Among the other risks, he says, are under-diversified portfolios and potential that the Food and Drug Administration might block new cannabis products. 

The safest-to-riskiest prospects, say Qiu and his co-authors, fall in this order: 1) large capitalized public companies with several product lines and a track record of success; 2) medium capitalized stocks that typically have one or just a few product lines; and 3) micro capitalized stocks, so-called penny stocks, with just one product line. 

In its white paper, which was overseen by Nunez, who also studied at Smith under Rinaldi and who later interned for him, the team looked at gross and net revenues during a minimum of three years and asked: "Do these companies have a diversified product offering with a competitive advantage? Does the company invest in research and development? And does the R&D budget lead to a large deficit?  They looked at how the cannabis companies trade in terms of depth, breadth and liquidity. And they determined that companies were safer bets if their product or products were in phase three of development or ready to commercialize.

Their research led them to these stocks — their hot list of cannabis investments: 

• INSYS Therapeutics, with a diverse pharmaceutical portfolio, stable revenue and earnings, and cannabis medicine in phase-three development
• Cara Therapeutics, with five mature diversified products that cover neuropathic chronic and acute pain, plus forthcoming products in phase three development 
• GW Pharmaceuticals, a biotech firm with phase-three products in the pipeline and financials that are relatively healthy 
• Canopy Growth, publicly traded on the Toronto Stock Exchange, with core brands Tweed and Bedrocan increasing its gross revenues 

To be sure, there are risks to the cannabis industry that go beyond product development and consumer tastes. And that makes predicting this market a particular challenge. 

"President Trump may continue the pursuit of change for change's sake and therefore increase the risk for investors contemplating exposure to this arena," Qiu and the authors say in their white paper. And, even as states continue to legalize pot, for medicinal or recreational use, investors still must account for the risk of companies failing to get their new products approved by the FDA.

Moreover, many cannabis companies are small and lacking in financial strength, and efficient management and operation, the researchers wrote. "Typically their costs are not carefully monitored and budgeted."