The Cannabis Stocks Dream Looks More Like a Nightmare. Stay Cautious.

Investing and trading cannabis stocks has been extraordinarily difficult. I feel for those who took a bet for all the right reasons (which we’ll get into). But the entire space has been incredibly challenged. If we look at the Global X Cannabis ETF (NASDAQ:POTX) as a proxy, it’s clear that investors have felt pain for a few years.

But is there perhaps an opportunity in cannabis stocks now?

First, we should distinguish between cannabis dispensaries and companies tied to cannabis with public markets.

The legal cannabis industry has witnessed dramatic growth in recent years. On the surface, this seems like a no-brainer investment. We can see it and smell it almost every day. However, despite its potential, the cannabis industry is fraught with challenges. It is characterized by high risk, regulatory uncertainty, and financial restrictions. Moreover, the lack of federal legalization in the U.S. and taxes have hampered the growth of cannabis businesses. In turn, this has hampered both stocks and exchange-traded funds playing the space.

Federal illegality of cannabis in the U.S. makes it difficult for these companies to secure loans, list on major U.S. exchanges, and take certain tax deductions and credits that federally legal businesses enjoy.

This has led to a challenging financing environment, which has been exacerbated by the recent regional banking crisis.

The point here is that there’s no uniform regulation and way for cannabis companies to properly interact with the financial system like nearly every other industry. Moreover, the cannabis industry is not uniform. It comprises two distinct segments – medical and recreational – each with its own set of challenges.

The medical cannabis industry involves considerable research and development, clinical trials, and distribution, similar to traditional pharmaceutical companies. The recreational cannabis sector revolves around branding, marketing, and consumer segmentation, akin to the tobacco or alcohol industries. Regulations on the federal level ultimately need to address both – difficult with inertia in Congress.

Cannabis Stocks Face Legal, Regulatory Hurdles

Many of the challenges facing the cannabis industry stem from legal and regulatory restrictions. The Secure and Fair Enforcement (SAFE) Banking Act is one such act of legislation that is pending review by the Senate, but never seems to quite get close to the finish line. This has always been the key piece of legislation needed for cannabis to really run.

The SAFE Banking Act aims to protect banks and other institutions that service state-legal cannabis businesses from federal penalties. If passed, it would allow cannabis companies to access banking services, which could significantly boost the industry. It would also make investing in cannabis stocks and ETFs far more palatable from a fundamental perspective. Moreover, the U.S. Department of Health and Human Services’ recent recommendation to reclassify cannabis as less risky could further raise the outlook for the cannabis industry.

However, until such reforms materialize, the cannabis industry will remain hamstrung, making the current market more suitable for investors willing to hold onto cannabis stocks in the hope that federal reform will boost their valuations. And unfortunately, that hope shimmers and fades continuously. That of course is not to say one should totally avoid investing in cannabis, but rather that it’s an immense headwind for real performance to match its domestic private company growth.

How to Invest in Cannabis Stocks Now

So how does one invest in cannabis? One approach is to invest Cin multistate operators (MSOs) – large cannabis companies that operate in more than one U.S. state where the drug is legal. These companies offer advantages for investors willing to buy shares and hold them for a considerable time. Some leading MSOs include Curaleaf (OTCMKTS:CURLF), Trulieve (OTCMKTS:TCNNF), Green Thumb Industries (OTCMKTS:GTBIF), and Verano (OTCMKTS:VRNOF). These companies have reported significant revenues, are consistently profitable, and are making strategic decisions to expand their market share.

Another approach is to consider companies based in Canada where cannabis is federally legal. Canada-based companies, as well as U.S. companies that do not earn money from plant-touching businesses domestically, can list on major Canadian exchanges. This has allowed them to secure coveted listings and raise capital more easily.

In addition to stocks, investors can also consider ETFs that provide exposure to the cannabis industry. ETFs offer a diversified way to invest in the sector, reducing the risk associated with investing in individual stocks.

The Bottom Line

I’m bullish on the space from a very, very long-term horizon, and perhaps short-term momentum kicks in. But reform at the federal level is critical, and uncertain. And with the industry likely to undergo consolidation, only the strongest players will survive.

It may be worth taking a small portion of your portfolio and investing it, just don’t look at that portion of your portfolio for a while. It will either act like an out-of-the-money call option and be worth a lot, or not worth anything at all.

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.