Prediction: Marijuana stocks will lose their (bad) reputation… Eventually

Among many experienced investors, the consensus seems to be that marijuana stocks are uninvestable. It’s not too surprising. Over the past three years, despite the market’s 23% gain, many major marijuana stocks have fallen 65% or more.

But industry leaders will eventually overcome this stigma. Here’s what you should look for to know which companies to buy so you can benefit when that happens.

Understand why many investors avoid the industry

Despite the recent trajectory of cannabis stocks, it’s probably not the main cause driving away investors.

In short, the North American cannabis industry is relatively new, as marijuana legalization in Canada is less than a decade old, and the US still uses a patchwork of state-level legalization policies rather than a unified set of federal regulations. New markets tend to follow the same development sequence, the early stages of which tend to be difficult for most investors.

First, players enter the market by obtaining the relevant regulatory permissions from the government and try to capture as much market share as possible. For cannabis companies, this process involves expanding cultivation capacity and production facilities, as well as distribution and retail networks, with a focus on areas expected to be sources of demand. As an example, Tilray Brands (TLRY -3.24%) it is currently targeting growth in soon-to-open or recently opened markets in the EU, such as Germany and Portugal.

Then, at some point, aggregate output outstrips demand, and growth becomes harder to come by—unless it’s at the expense of one competitor to the benefit of another. A dead ringer for this phase is when key prices begin to drop significantly, as the price per gram of cannabis in the US did in late 2023.

Next comes the hustle, which is where the industry is right now.

During shakeout, weaker competitors begin to lose market share. Also, their stocks tend to drop quite a bit. Inevitably, the stronger competitors are the ones with wider margins and are usually positioned to buy the remnants of others, even if they are not consistently profitable. And because the powerful tend to be better capitalized, they can afford to take a little longer to become effective in the new and somewhat more hostile environment.

SNDL (SNDL -2.37%) is a player who is likely to survive this period. After lending significant cash to smaller operators over the past two years, it is now buying up some of its borrowers at a discount. At the same time, it reduces part of its head to become more efficient.

The final phase is when the market stabilizes and maturing competitors find their place, with industry leaders both profiting and growing despite earlier upheavals. This is where companies with competitive advantages will begin to break away from the pack and show their long-term strength.

And the cannabis industry will get there eventually. When he does, his reputation will recover. The only alternative to a recovery would be for it to wither over time, which won’t happen as long as there is demand.

Take a conservative approach

It could be years before cannabis companies are considered valuable investments on par with other consumer recreational products industries such as the liquor industry. There is likely to be a gap, perhaps a long one, between when the financials start to look better and when investors recognize that the turbulence of the start-up period and subsequent shakeout has given way to a more stable set of companies that can be invested. .

It is entirely possible to experience solid returns by investing before then. Focus your efforts on businesses that are making the most progress towards profitability while continuing to grow, such as SNDL. Be aware that it will be a risky endeavor until there is a year or two of stability.

Until that happens, these stocks are not suitable for risk-averse investors, even though they may be in the future.