Pot stocks are losing ground now that Canada has legalized cannabis for recreational use. Shares skyrocketed in the months leading up to Oct. 17 as analysts started to raise the alarm about the sector possibly being in bubble territory.
Companies across the sector suffered losses on Monday. The ETFMG Alternative Harvest ETF (MJ) fell 9.4% at the close after 28 of its 37 components ended the day in the red, reported MarketWatch. A particularly torrid day on the markets for the three biggest pot stocks, Tilray Inc. (TLRY), Canopy Growth Corp. (CGC) and Aurora Cannabis Inc. (ACB), translated to a 20% drop for the ETF over the past five-sessions, its biggest loss since it was brought to market Dec. 3, 2015. Canada-traded Horizons Marijuana Life Sciences Index ETF (HMMJ) also had a difficult day, falling 11.6%, the largest drop in the fund’s history. HMMJ is now down 24.3% in the past week.
Analysts Weigh In
Investors speaking with CNBC pointed out that Monday's sell-off may be due to a degree of profit taking after the excitement of the past few weeks.
Several analysts covering the sector had predicted that pot stocks would lose their luster once the drug was finally legalized in Canada. Hamish Sutherland, CEO of White Sheep Corporation, told Vice that investors were likely to “freak out” because of high valuations and October being “ a notoriously bad month for the market.”
On Oct. 16, NYU professor Ashwin Damodaran also warned that "the numbers are not there yet" in a conversation with CNBC. He told potential cannabis investors to "stay out for the moment" because of sky-high valuations and added in his blog that revenues and profitability of legal weed businesses will be reduced due to unregulated and untaxed competitors selling a cheaper product.
Analyst Nigam Arora said that naive investors could possibly lose 90% of their investments and smart money sold because it "knows the big Canadian marijuana nightmare ahead." He says that the total valuation of Canadian companies is likely to drop from $125 billion to $10 billion if significant international operations for these companies do not materialize.
Scott Willis, head of research at investment research company Grizzle, even claimed that share prices will fall by about 60%, according to MoneySense.
Willis took issue with Canadian sales estimates, arguing that they failed to take into account the lure of the black market. According to the analyst, people will continue to buy their goods on the black market for at least another year because dealers do deliveries, their products are less expensive and edibles will remain illegal until late 2019. “The black market already has this stuff and will deliver the same day,” he said.
Once the market recognizes that demand isn’t as strong as the Canadian government first suggested, Willis reckons companies serving the market will tank. “The government has set expectations of what they think demand will be in the first three months,” he said. “They’ll then put out a press release in January saying what demand really was and if that misses, which is pretty likely, all the stocks will tank. People will be worried that the market isn’t converting to legal as fast as they thought.”
Amid all this uncertainty, the analyst added that pot stocks face the difficult challenge of finding the correct balance between supply and demand. If they fail to produce enough, their earnings will fall, he said, before adding that too much supply will lead to a similar outcome.