Making Sure Your Money Doesn’t Go Up in Smoke

Pot stocks are off and running, thanks to Canada’s vote to legalize weed this summer. Judging by the wild swings they’ve shown in value, they’re practically the new Bitcoin. Once tiny startups like Tilray Inc., Cronos Group, Canopy Growth Corp., and GW Pharmaceuticals seemingly exploded overnight into multi-billion-dollar concerns.

It’s a tough call for investors who are keen on the sector to decide whether to get in on the action now or wait to see whether some of the hot air comes out of the stock prices first. With legalized weed sales set to begin Oct. 17, the clock is ticking.

Before you start calling your broker and start plunging your savings into the next hot pot stock, be aware that it’s a frothy market where things might not always be what they appear.

Now is the time when stocks might be over-hyped, when companies might be over-selling themselves, and when overly-ambitious claims are made. When the market starts to cool down, you probably want to feel like you’ve made a wise decision to invest in a growing business, not in a mirage whose stock will drop like a rock when the tide of exuberance goes out.

The U.S. Securities and Exchange Commission has warned investors to make sure pot companies are legit, and to be wary of fake press releases pumping the stock, or any claims of implausible high returns.

Here are some things to keep in mind when you are considering investing in a cannabis-related equity. If a public company is later discovered to be lying about these important facts, it could be liable for securities fraud.

Management team:

Anytime you invest in a fledgling company, whether it be marijuana-related or otherwise, it can give you peace of mind to know there’s a solid team in place steering the ship. Ideally, you want to see a founder with a strong vision and a good track record in business surrounded by other players and a board with experience in public company management and a diverse range of skills. Pay attention to whether the company has well-known auditors and legal advisors, too.

Company strategy:

What specific type of cannabis-related business you are investing in? Is it a grower, like Canopy Growth, which produces marijuana? A cannabis-focused biotechnology firm like GW Pharmaceuticals, which concentrates on creating marijuana-derived drugs? Or is a provider of ancillary products and services to the industry, such as packaging, lighting, or supply chain management?

Does it focus mostly on the medical marijuana business, or is it more geared toward recreational users? Does the company have solid partnerships with distributors and other supporting players necessary to stay in business?

Finances:

Similarly you should spend some time looking at the company’s finances, and at least familiarize yourself roughly with what it has in assets, cash, debt, revenue, and expenses. Many marijuana companies are not yet turning a profit.

That might not necessarily be a problem, since after all, they are gearing up for legalized sales. But they should have assets you would expect to see for whatever type of business they are handling, cash to pay bills as they come due, and not so much debt that they could be easily overwhelmed by a hiccup in sales.

Legal risks:

All pot companies face legal risks stemming from the fact that their businesses are well, not legal everywhere. Pay attention to the disclosures concerning those risks. If there are no legal disclosures, consider that a red flag that you may be dealing with a company that isn’t being straight with investors about the possible drawbacks. Who knows what other problems they could be hiding.