CANNABIS STOCKS SEEM TO BE THE HOTTEST GAME IN TOWN BUT CAUTION IS WARRANTED
Investing in startups can be risky business,
Nobody wants to miss the party. It seems like a lot of fun. Who doesn’t want to make a lot of money very fast?
Not surprisingly, we often get asked the question “Should I be investing in marijuana stocks?”
Our answer is invariably “No!” Here is why.
Most of our clients are over 50 and have built up enough assets that they are close to or already past the point of needing to worry about outliving their funds. Even so, they still often have that worry. Early on, we ask our clients for their goals. They usually relate to financial independence for the rest of their life, being tax smart and, where possible, wanting to help their children and/or charities when the time is right. Of course, one of the key parts of determining if they can achieve these goals relates to various assumptions of the future. The key assumption relates to investment performance.
We usually build a financial plan for a client that is based on long-term investment returns in the five per cent to seven per cent range after any fees. Returns can also be looked at as the rate of inflation plus three per cent to five per cent. The investment range is largely based on how conservative or growth oriented the client might be. We are confident in achieving these numbers based on the long-term history of stock markets, bond markets and, to a lesser extent, preferred shares. We also have the ability to look at certain private investments — especially in the lending market — that have helped to make these returns quite likely over time.
If we assume a long-term return of six per cent on investments in a financial plan, one of our key jobs is to try to achieve that return in a way that is tax efficient and, most importantly, achieved with lower volatility than would be found in stock markets. This issue of volatility is very important. Clients will be much more likely to stick to a long-term investment plan if they don’t face major losses along the way. We are all aware of how difficult it was to stay invested in stocks in late 2008 when it seemed like they simply went down every week. As a result, we want to meaningfully limit the downside in a portfolio.
This brings us back to the question, “Should I be investing in marijuana stocks?” Given who our clients are, and their objectives and their fears, we are confident of achieving their goals in part because we can invest in an entire world of stocks, bonds, preferred shares, ETFs and alternative investments. Each investment can be analyzed to determine how it will add to our clients’ investment goals. We can see cash flows, profits, dividends, credit quality, momentum and security on debts. This analysis gives us comfort in achieving the numbers in a plan for the client. It also gives us the confidence to ignore certain investment sectors that don’t fit into our criteria.
Marijuana stocks are all startups. Most have not yet achieved any profitability. The industry itself is in its infancy. Product pricing, and therefore profitability, is still very much a question mark. The sector may turn out to be the answer to a wide range of issues like pain management, miracle cures, and even a partial replacement for alcohol. At the same time, none of this is known, and possibly none of it will turn out to be the case.
The idea of first-mover advantage may be important, but considering that everyone on your street will be able to legally grow marijuana, and farmers in many corners around the world can easily grow the crop (legally or illegally), how much benefit will an early mover really have? How can any of these companies reliably be worth more than American Airlines, Canadian Tire or Goodyear? Essentially, we believe that the sector is a gamble. If you are younger and rolling the dice for a big win, then by all means invest here, but if you are on pace to achieve your goals without it, why roll the dice?
If we remember that one of the biggest risks to a long-term plan is to buy high and sell low, we do our best to avoid investments where the move from low to high has taken place very quickly and without strong investment fundamentals. These investments have a much higher risk of reversing ground with the same speed. While the marijuana sector is exciting, in our opinion, it has some real risk of fitting into exactly what we don’t want as part of a long-term plan.
I am not saying that people can’t still have some fun money, and maybe invest two per cent of a portfolio in something speculative, but we won’t proactively do that with our clients’ money. We don’t need to, and they don’t need to, and there is a real possibility that the marijuana story won’t end well for investors.
When the world is full of investments backed by positive cash flow, dividends, and relative stability, why risk your retirement on anything else?