Five reasons to buy cannabis stocks after a punishing rout

There’s potential good news ahead, which could quickly change sentiment in the marijuana industry

Cannabis stocks have sent investors on a wild ride in the past year.

Shares in the burgeoning industry had halved by the end of August compared with a year earlier, when they were pushed higher by bullish sentiment. Canopy Growth and Tilray, two bellwethers, had plummeted even more — by 54% and 64%, respectively. The popular ETFMG Alternative Harvest exchange traded fund had fallen 45%.

But cannabis investors, take heart. Cannabis stocks are about to get higher valuations. That’s because the selling became so extreme last month, marijuana stocks hit capitulation lows Aug. 28, the Bear Traps Report’s Larry McDonald wrote on that day.

He suggested investors take opening, one-third positions in the ETFMG Alternative Harvest ETF as a contrarian bet on the group. McDonald made a good call, even if he stopped short of saying go all in. Since then, cannabis stocks have rallied nicely.

But they have more to go. Capitulation lows are blow-off events in which most of the losers and weak hands finally throw in the towel. As such, they can punctuate a bottom by clearing the negativity, and serve as the starting point for a sentiment reset. All the bad news — and there is plenty of it — seems to be priced in. Yet several catalysts loom. They will continue to fire up sentiment.

Cannabis stocks do not have the insider buying I normally like to have on my side, but they’re disliked enough to give them the out-of-favor contrarian profile I like to see to put names in my stock letter, Brush Up on Stocks.

Here’s a look at what’s gone wrong — and what could go right — to continue driving marijuana stocks higher, even if it won’t be straight up.

Catalyst No. 1: Branded edibles begin to take off in Canada

A big knock on cannabis companies is that weed is a boring commodity, much like corn or wheat. This is such a common gripe, it’s a mere cliché by now. But publicly traded cannabis suppliers do need to break out of commodity jail. To do so, they have to learn how to be to marijuana what Coca-Cola and Pepsi are to sugar water. They have to develop powerful brands in higher-margin derivative products such as edibles, vapes and drinks that consumers love.

They’re about to get their first big shot on goal in Canada, which has been paving new ground in legalized cannabis.

Until recently, Canada had only approved the sale of bud, oils (tinctures) and gel caps. Now that’s changed. Canada recently cleared the way for legal edible products, vapes and cannabis drinks. They will start hitting the shelves in December. This development — and the buildup to it between now and then — will generate a lot of buzz among cannabis investors, and shift the sentiment needle back toward bullish. That will push cannabis stocks higher between now and year-end, and beyond.

“We will see a slew of new products hitting the market,” says Korey Bauer, portfolio manager of the Cannabis Growth Fund. “We think this is going to be massive for these companies.”

“I’m personally really excited about edibles legalization in Canada,” says Motley Fool investment analyst Emily Flippen, who studies the cannabis space. She says it will give companies the chance to sell higher-margin products, and shake off their commodity status. The edibles and vape breakthrough will also broaden the appeal of cannabis among consumers.

To understand why, consider how popular these products are in the U.S. market. Derivative cannabis products — as opposed to plain old bud — account for roughly 60% of sales in the legal U.S. markets and a disproportionate percentage of growth, says Stifel analyst W. Andrew Carter.

In a follow up column on cannabis names, I’ll present the companies most likely to benefit from the changes in Canada and the all-important brand development opportunity coming down the tracks as a result.

Catalyst No. 2: Trump (potentially) comes to the rescue

Political analysts claim to be unsure about President Donald Trump’s views on cannabis. But there are plenty of signs that Trump doesn’t have the typical New Yorker’s “live and let live” outlook. He hired (and then fired) an attorney general who vowed to enforce federal prohibition of cannabis. Surgeon General Jerome Adams just published a scathing report on the very real health risks of weed, which I have also written about. Trump himself is donating part of his salary, about $100,000, to fund a media campaign on marijuana risks.

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