Pot Penny Stocks - dummies

By Peter Leeds

There have been many cases of penny stock manias throughout the decades. One of the most recent and significant manias surrounds the growing acceptance of marijuana.

Medical marijuana has been a growing trend for years. However, the social movement for medicinal cannabis has been slow, and limited to small percentages of people with specific illnesses that may be helped by cannabis. This has not allowed the concept of medical marijuana to ignite a stock market mania.

On the other hand, as legal recreational marijuana burst on the scene in Colorado, a whole plethora of tiny cannabis businesses sprung up. Unfortunately, some of these were mainly in name and concept only, while others bled money by the tens of millions of dollars from their underlying operations.

Yet as a true mania demands, very few investors looked at the company’s operational results, balance sheet, or revenue levels. The end result was that many of their shares skyrocketed to absolutely ridiculous levels, driven by eager investors, before hitting the wall and collapsing in price. There were companies valued at half a billion dollars with only a handful of employees. Others were tens of millions in debt, with not a penny in revenues, and no prospects for sales any time soon.

The absolute worst cases involved those businesses that simply claimed to be loosely involved in the cannabis industry by way of providing consulting services, but had no experience or business model to back those claims up. In one case, an old, near-defunct mining company added the word Cannabis to its name, and the shares instantly doubled. From Australia to Western Canada, shells and barely functional junior mining companies started getting in on the pot craze.

Recreational marijuana wasn’t all bad. Within the first two months of legalization in Colorado, property crimes dropped 14 percent, homicides fell 67 percent, and robberies dipped 7 percent (according to the Colorado Department of Public Safety). Tax revenues were expected to be between $20 million and $134 million (according to the Associated Press). So, overall, it appeared to be working well for the state at first glance.

The media was all over this story of course. The pot penny stocks were starting to soar.

Unfortunately, it wasn’t so great for investors. All manias end in spectacular fashion, and this would be no exception.

The rise and fall of pot penny stocks

Typically, the faster a penny stock rises, the quicker it falls. This couldn’t have been more accurate than for the pot companies, and this mania played out exactly as you might expect.

Consider this timeline of events:

  • March 2012: Recreational marijuana becomes legal in Colorado and Washington. This was enough to get the media onboard — it was a pretty big deal. This was a newsworthy event, and the nation was watching closely to see how everything would work out.
  • Late 2012: Companies started jumping on the trend. Businesses that could show involvement in the pot trade saw their shares begin to soar. Many of these companies were already “in the biz” but could best be described as mom-and-pop shops. Others were small groups of marijuana-enthusiast friends.
  • 2012 to 2014: Problems abound for the penny stocks. Investors got ahead of themselves in a big way. Marijuana was still illegal from a federal perspective, and there were almost no barriers to entry into the space. Meanwhile, these companies were soaring hundreds of percentage points in share price but had anemic or nonexistent revenue streams. The operational losses made the picture significantly worse.
  • Early 2013: The second wave of companies jump on the bandwagon. These were the worst of the bunch, using cheap tricks like adding Marijuana or Cannabis to their names to attract investor dollars into their barely operational companies. Boy, did it work.
  • Early 2013: Pot penny stocks spike. As just one example of many, a particular company with Canna in its name went from not trading in 2012, to going for a couple bucks a share in early 2013, to topping out at more than $200 in early 2014.
  • Early 2014: Pot penny stocks collapse. The aforementioned shares fell from the $200 peak to $20 within two months, then toward $1 a few months later. This was typical activity for all companies involved in the entire pot penny stock mania.
  • 2014 to present: Other states legalized recreational marijuana. The trend grew, with Alaska, Oregon, and the District of Columbia legalizing. Still more states are currently considering joining the ranks. The concept is growing in popularity, but that won’t help investors who got caught in the mania. That investor stampede has now come and gone.

Although automobiles and green technologies are both a great idea, investing in their stocks was not such a good move. It is no different in pot penny stocks, even if the idea’s time has come and recreational marijuana will become legalized nationwide. The idea should be considered separate from the stocks.

Looking “under the hood” of cannabis companies

Checking on the quality of a company is pretty quick and simple. A quick look would have saved hundreds of thousands of investors from calamitous losses, because they would’ve known to avoid the investment in the first place.

The following examples were typical for the entire cannabis industry. Consider these points of concern, which were publicly available to anyone who would’ve taken the time to look. Many of the businesses involved in the marijuana industry had no revenue over five years or more. Their business models might have changed from oil and gas to cannabis consulting, seemingly overnight.

A company might have been valued at nearly a billion dollars with only $2,000 in sales. One company had $9,000 in assets and $6 million in debts. Most of the companies had fewer than six employees. Many were brand new and hadn’t even reached the “proof of concept” phase. Some executives started getting arrested for fraud and insider trading. And finally, almost all marijuana penny stocks were bleeding cash at an astounding rate.

The further the share prices climbed, the worse the end result would be for shareholders. Instead of feeling good about making 40 percent, despite the underlying business being near bankrupt, investors held on. The shareholders rode the stocks down to levels well below where they had originally purchased in the first place.