BUT IS IT TOO LATE TO GET INTO POT STOCKS?

The historic Senate vote passing legislation to legalize recreational marijuana sent Canada’s biggest cannabis stocks on a roller-coaster ride Wednesday, with many surging at the open before falling back and then rallying to end the day. For example, Canopy Growth

Corp., Canada’s largest producer, jumped 5.3 per cent on the early euphoria, then fell 5.9 per cent within two hours, before climbing back to end the day up 6.7 per cent. Shares of Aurora Cannabis

Inc. (up 4.7 per cent), MedReleaf

Corp. (3.5) and Aphria Inc. (4.2) followed a similar pattern.

Valuations have crashed and boomed over the past year as cannabis companies struggled to find equilibrium. Even on a day-to-day basis, shares have been dangerously volatile.

But while legalization may mean they are not as speculative as they were even a few days ago, analysts warn that investors looking to get into the game should be screening for key traits.

Analyst Jason Zandberg at PI Financial says investors need to be exceedingly careful in this kind of market. He believes the number of producers jockeying for position will unavoidably lead to a glut within three years, so we’re bound to see a period of consolidation.

“I don’t think it’s too late, but I do recommend that investors be very selective,” he said. “If you look at any developing industry, there tends to be a shakeout that happens and the winners emerge.”

Graeme Kreindler at Eight Capital concurs. In a note Wednesday, Kreindler says investors should be focused on producers with leading levels of inventory, supply agreements with provinces or other viable channels.

Mid-cap mainstays like Canopy Growth Corp.,

Aphria Inc. and Aurora Cannabis Inc. are all obvious contenders to become industry leaders, but Zandberg has OrganiGram Holdings Inc. (trades: $5.70; target: $7.50) and Cronos Group Inc. ($7.30; $13) as his top picks.

Kreindler believes an industry shakeout could also

bring opportunity. In his note, he highlights firms that could expand through takeover, such as CannTrust

Holdings Inc. ($8.88; $14.25), OrganiGram ($5.70; $7) and The Hydropothecary Corp. ($4.96; $7.25). Another strategy might be to focus on underdeveloped industry segments, where the rise in valuation hasn’t been as dramatic, such as retail. A lack of regulatory certainty has held up progress in this area, but things are going to start moving quickly now that legislation is approved.

Kreindler anticipates Royal assent within days, and regulation to follow within eight to 12 weeks. Initially, only mail-order sales are anticipated as the provinces develop the required regulation and retail infrastructure.

For investors looking for a nice speculative buy in retail, Zandberg points to National Access Clinic Corp.

The company has a deal with coffee chain Second Cup that would see some stores converted into cannabis dispensaries.

NAC already has a licence in Manitoba with applications pending in Alberta and British Columbia, but there’s also the possibility that Ontario’s newly elected Conservative premier could reverse the previous government’s position and open the door to private cannabis retail.

That would represent a significant opportunity for NAC, said Zandberg. “If the Ontario government changes its approach and allows private companies, obviously that’s going to mean a huge positive impact on National Access Clinic.”

U.S. retailers may be another good bet, says Zandberg, who says that American states have been far more entrepreneurial in their approach to cannabis retail.

“The valuations are much better on some of these U.S. cannabis names,” he said. “And the U.S. represents (a) much more open entrepreneurial market than Canada.”

Whereas private Canadian retailers — where they’re not prohibited, in B.C., Alberta, Saskatchewan and Manitoba — will have to contend with limits on advertising and product type, retailers in Nevada, California and Colorado are free to create flashy brands and sell innovative products like edibles and vaporizer pens.

Cannabis firms south of the border may be stymied for the time being by the federal/state duality in criminal law, where the feds have outlawed practices that the states have expressly permitted. But the law around cannabis is evolving rapidly, and with de facto legalization already a reality in eight states, Zandberg says he wouldn’t be surprised if the White House changed its tune in coming years.

“We’ve seen a huge change in social attitude toward it and I wouldn’t be surprised if Trump changes his stance,” he said.