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Reefer madness? Take a pass on marijuana stocks for now

Jan 12, 2014 @ 12:01 am

By Jeff Benjamin

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With recreational marijuana use now legal in Colorado and Washington, and Alaska looking to be next in line, it is tempting to sit back and ponder some deeper issues about society and laws.

For instance, am I the only one who thought California would be the first state to approve pot for recreational use, and what exactly do they mean by “recreational” use anyway? I can't help but imagine long lines at the Taco Bell drive-thru.

But this is an investment column, and despite the obvious temptation for endless puns and pot-smoking jokes, I will try to take the high road and concentrate on the new buzz surrounding many marijuana industry stocks that have been recently hitting new highs (sorry, I just can't help myself).

With 20 states and the District of Columbia now allowing the use of weed in some form, it isn't crazy to think there is some kind of potential investment opportunity.

But right now, while the legal landscape remains in flux, investors should probably avoid jumping headlong into marijuana stocks.

SOLAR ENERGY

Don't believe me? Think back to the start of another recent craze: solar energy.

In 2007, an RBC Capital Markets report projected a 40% increase in the use of solar power by 2011. Industry profits were expected to grow by nearly 50% over that period.

Some of the stocks highlighted in the report spent the bulk of the next five years getting crushed, if they even managed to survive.

For example, shares of SunEdison (WFR) dropped by an average of 36% a year through 2012 before gaining 300% last year. Meanwhile, JA Solar Holdings Co. (JASO), another favorite at the time, suffered declines of more than 80% in both 2008 and 2011, before gaining 114% last year.

Even if investors had adopted a more diversified approach through a mutual fund or exchange-traded fund, the experience would have been gut-wrenching.

The New Alternatives Fund (NALF), which highlighted solar energy as an important investment in 2007, lost 44% in 2008, and more than 7% a year in both 2010 and 2011, before gaining 30.5% last year. The PowerShares WilderHill Clean Energy ETF (PBW) fell by 69% in 2008 and also suffered three straight losing years leading up to a 60% gain last year.

PENNY STOCKS

And remember, in the cases of the stocks and ETFs, those dramatic surges last year came off of severely depressed levels.

At the risk of being a buzz kill, the truth of the matter is that hemp stocks are likely to be far more volatile than even those associated with solar energy.

Most of the stocks linked to the burgeoning marijuana industry are unlisted penny stocks, which are thinly traded and volatile by nature. Also, many companies with even a loose connection to weed sales and production have already experienced a stratospheric rally, fueled, possibly, by boiler room sales tactics.

In fact, in August, the Financial Industry Regulatory Authority Inc. alerted investors about the possibility of fraudulent sales of pot stocks, including the classic “pump and dump” scheme in which salespeople heavily promote a stock only to sell it sharply, dropping the price and leaving investors on the hook with the losses.

GreenGro Technologies Inc. (GRNH), which makes eco-friendly vertical-cultivation systems, has soared 1,900% since the start of the year to 80 cents a share. Prior to Jan. 3, GreenGro shares had gone 13 months without trading above 10 cents a share.

The stock price did gain 282% in 2012, but it also lost 93% in 2010.

The story isn't much different for GrowLife Inc. (PHOT), a maker of horticulture and “lifestyle” products that has climbed 190% this year to about 43 cents a share.

GrowLife's gain this year follows a 304% gain last year. But between 2008 and 2012, there were three down years of between 52% and 90%, and two up years of between 94% and 114%.

PRIVATE-EQUITY FUND

Those aren't the kind of swings that would make most investors rest easy.

One of the odder twists in the whole pot stock buzz (ahem), is the effort by High Times magazine to launch a private-equity fund that will invest in marijuana-related businesses.

The theory behind the HT Growth Fund is that it will be able to help finance the growth of some of the fledgling companies in the sector.

It is much too early to speculate on the future of any such private-equity fund, but on paper at least, it does seem like a way to lift some of the penny stocks onto some real exchanges.

Until that point, it might be best to just sit back and watch the show, while pondering when and how recreational marijuana might become legal in your state.

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