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5 Safe marijuana stocks for 2019

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"Safe" and "marijuana stocks" are words you usually don't find in the same sentence, and for good reason. Marijuana stocks are characterized by high risk and volatility. However, not all marijuana stocks are alike and some have considerably less risk than others.

These investments are not guaranteed wins, as no stock meets the absolute safety criteria. But relatively speaking, these marijuana stocks are safer picks than their peers. Here's what you need to know about five of the safest marijuana stocks for 2019.

Overview of the marijuana industry in 2019

Marijuana -- the flower buds and leaves of the cannabis plant -- has been in use for thousands of years. People have used marijuana to get high, thanks to its primary psychoactive ingredient tetrahydrocannabinol (THC). And they've used it for medical purposes, with another key ingredient, cannabidiol (CBD) especially possessing therapeutic benefits. People still get high using marijuana and use it for medical purposes today. Two different segments have emerged in the marijuana industry to serve these two separate purposes.

The more mature legal market is medical marijuana. Thirty-one countries currently allow legal marijuana for medical purposes. Thirty-one U.S. states have also legalized medical marijuana, despite marijuana remaining illegal at the federal level. Some states have also decriminalized personal marijuana use. While legalization allows marijuana to be used without breaking laws, decriminalization only relaxes the criminal penalties associated with violating marijuana laws.   

In addition, the U.S. Food and Drug Administration has approved three cannabinoids -- compounds found in cannabis. The FDA approved synthetic cannabinoids dronabinol and nabilone years ago for the treatment of nausea and vomiting associated with cancer chemotherapy, with dronabinol also receiving approval for treating loss of appetite and weight loss in AIDS patients. More recently, GW Pharmaceuticals won FDA approval for the first plant-based cannabinoid drug, Epidiolex, in treating two rare forms of epilepsy. Each of these prescription drugs is now available on the market in the U.S.

The legalization of recreational marijuana, however, isn't as prevalent. Currently, only two countries have legalized recreational marijuana at the national level: Canada and Uruguay. Mexico could soon follow, though, with its Supreme Court overturning the country's ban against recreational marijuana. In the United States, just 10 states have legalized recreational marijuana. Efforts to revise federal laws to allow states to enforce their own marijuana laws are underway. It's possible that these efforts will succeed in the not-too-distant future.   

Within the marijuana industry (including both medical and recreational segments), there are three broad types of stocks:

  • Marijuana growers
  • Cannabis-focused biotechs
  • Ancillary products and services providers

Marijuana growers cultivate cannabis plants, usually in indoor facilities or greenhouses, harvest the crops, and produce cannabis products for distribution to dispensaries or directly to consumers. Cannabis-focused biotechs develop prescription drugs made from cannabinoids. Ancillary products and services providers supply marijuana growers and/or cannabis-focused biotechs with key products and services used in their businesses.

Pot stock volatility in 2018

Nearly every marijuana stock exhibited considerable stock price volatility during 2018. There were several causes for this wild fluctuation, although not every reason applied to every stock.

The U.S. federal government contributed to the volatility of many marijuana stocks. Former U.S. Attorney General Jeff Sessions started off 2018 with a move that threatened the U.S. marijuana industry. Sessions overturned Obama administration policies that largely kept the U.S. Department of Justice from intervening in states that had legalized marijuana. Although the DOJ ultimately didn't prosecute any marijuana businesses, Sessions' action caused a lot of concern for marijuana investors who worried the companies they invested in may be raided and shut down by federal agents.

By April, Sen. Cory Gardner (R-Colo.) had reached a deal with the Trump administration to keep the federal government from enforcing these laws in states where marijuana was legalized, including Gardner's home state. President Trump also signaled his support for legislative efforts to revise federal laws to allow states to make their own decision about marijuana legalization.

Beyond issues caused by federal U.S. laws, certain state markets suffered. California's recreational marijuana market got a sluggish start thanks to excessive taxes and onerous regulations, which created headaches for companies heavily dependent on the state's marijuana market. Many individuals opted to buy marijuana on the illegal black market at cheaper prices than available legally. 

An even bigger focus was placed on Canada. The largest marijuana growers are based in Canada, primarily because the country's medical marijuana market is relatively mature compared to most other countries. As a result, investors paid very close attention to what went on in Canada during 2018 related to the marijuana industry. Anticipation of the Canadian Parliament's votes on the legalization of recreational marijuana kept investors on pins and needles. While most expected passage of the bill, there was some drama along the way that contributed to the volatility for marijuana stocks. 

Many marijuana stocks enjoyed a nice positive run-up in price not long after the June passage of the legislation to legalize recreational marijuana in Canada. But when the long-expected opening date for the Canadian recreational marijuana market arrived on Oct. 17, 2018, marijuana stocks experienced a letdown as investors appeared to worry that sales would suffer in the wake of supply shortages. Although the Canadian marijuana industry had ramped up production capacity, there wasn't nearly enough supply of recreational marijuana to meet the pent-up demand. 

On top of all of these government-related causes for volatility, most marijuana stocks' market capitalizations -- the total value of the companies' shares by multiplying the stock price by the number of shares outstanding -- were inflated as investors drove the stock prices higher on hopes of tremendous growth. The high share prices made marijuana stocks more susceptible to sell-offs on any bad news.

This phenomenon isn't limited to only marijuana stocks. Marijuana stocks belong in the category of growth stocks -- stocks for which increasing share prices are expected to generate returns rather than dividend payments. Growth stocks, in general, tend to be more expensive and volatile than other stocks. This is largely because expectations of growth are usually somewhat subjective, and negative developments can shake investors' confidence in their initial assumptions about a stock's growth prospects. 

However, the relatively high valuations have also attracted short-sellers to some marijuana stocks. Short-sellers borrow a stock then sell it in hopes that the share price will fall and they'll profit by buying the shares they borrowed at a lower price.

But when a stock price goes up significantly, short-sellers often scramble to buy their borrowed shares to avoid an unbearable loss. This creates a situation called a "short squeeze," where buying pressure created by short-sellers drives share prices much higher. Some marijuana stocks' volatility increased as a result of such short squeezes and the drop in share price that often accompanies the end of a short squeeze. Shorting stocks, by the way, is very risky -- a spike in a stock's price can quickly cause huge losses -- and isn't something that most individual investors should attempt. 

Safe marijuana stocks for 2019

Investing in stocks is inherently associated with risk. That's especially true for marijuana stocks. But five marijuana stocks appear to be relatively safe for investors to consider in 2019: 

1. Constellation Brands

Perhaps the safest marijuana stock bet is not a marijuana stock at all but is instead beverage maker Constellation Brands. Constellation makes the list as a marijuana stock thanks to its 38% stake in pot producer Canopy Growth. 

What makes Constellation Brands such a relatively safe pick? First and foremost, the company's core business gives it both growth and stability that most pure-play marijuana stocks don't have. Constellation ranks as the top alcoholic beverage company by far in terms of U.S. retail sales growth. The company by itself contributed close to 35% of total industry growth in the 52 weeks ending Aug. 12, 2018, with its second-place competitor generating sales growth less than one-third of Constellation's. 

The key to Constellation Brands' success in the alcoholic beverage industry has been its focus on premium brands. Constellation is the No. 1 high-end beer maker in the U.S. with popular premium imports including Corona and Modelo. Its Svedka brand is also the top imported vodka in the U.S.

Constellation Brands is highly profitable with consistent double-digit percentage earnings growth. The company returns a portion of these profits to its shareholders in the form of dividends. Constellation's dividend yield (dividend per share divided by share price) currently stands at 1.6%.

But Constellation Brands' investment in Canopy Growth also gives the company a solid opportunity in the booming marijuana market. The two companies first teamed up in 2017, with Constellation buying a 9.9% stake in Canopy and establishing a partnership to develop cannabis-infused beverages. Constellation saw the opportunity to market a new category of beverages to drive growth as well as offset any potential loss in market share for its alcoholic beverages to recreational marijuana products. 

The stock is listed on the New York Stock Exchange (NYSE), which prohibits members from conducting operations that are illegal at the federal level in the U.S. This means that Constellation won't be able to market recreational marijuana products in the U.S. until marijuana is federally legal in the country. However, Constellation and Canopy Growth are targeting the Canadian market. Canada is expected to finalize its regulations for cannabis edibles, which include cannabis-infused beverages, in 2019.   

Constellation spent around $4 billion in August 2018 to increase its stake in Canopy. The company expects the dynamics of the recreational marijuana industry to be similar to those of the alcoholic beverage industry and play to its strengths in building highly profitable consumer brands.

2. Canopy Growth 

Canopy Growth's fortunes, on the other hand, rest solely on growth in the global marijuana market. However, Canopy appears to be one of the safest plays to profit from this growth because of its market position and its relationship with Constellation Brands. 

How does Canopy's market position make it a safer pick than most? One example is that the company claims the largest supply agreements for the Canadian recreational marijuana market of any licensed marijuana producer in the country. That means Canopy has greater assurance that its products will be purchased than most of its rivals. One of the primary reasons why Constellation acquired a major stake in Canopy was that it has the top market share in the Canadian recreational marijuana market.

Canopy Growth also has one of the most extensive international operations in the marijuana industry. The company is a top supplier in Germany, which legalized medical marijuana in 2017 and has the largest marijuana market outside of North America. Canopy's international subsidiaries operate in Australia, Chile, Colombia, Czech Republic, Denmark, Jamaica, and Lesotho. In addition, the company has a joint venture with Entourage Phytolab in Brazil.

Canopy's relationship with Constellation Brands cements its leadership position even further. Thanks to the investment from Constellation, no other marijuana grower has the amount of cash available for additional expansion internationally than Canopy does.

This cash advantage could be especially helpful with the U.S. legalization of hemp -- cannabis with very low levels of psychoactive compound THC. Cannabis market research company Brightfield Group projects that the U.S. market for hemp-based CBD products will reach $22 billion by 2022. CBD, like THC, is a cannabinoid. Unlike THC, though, CBD isn't psychoactive. 

Canopy Growth founder and co-CEO Bruce Linton hinted in November 2018 that the company would be ready to jump into the U.S. should hemp be legalized. Such a move now seems very likely and Canopy is positioned to scale up. With Constellation at its side and Constellation's cash in its bank account, Canopy Growth should be able to enter the massive U.S. opportunity in a bigger way than most of its peers, helping increase the stock's relative safety.  

3. Scotts Miracle-Gro

Scotts Miracle-Gro isn't a marijuana grower like Canopy Growth. Nor does it own a stake in a pure-play marijuana company like Constellation Brands. However, Scotts has quickly become the top supplier to the U.S. cannabis industry. Thanks to a string of acquisitions, Scotts Miracle-Gro's Hawthorne Gardening subsidiary now offers a wide range of products to marijuana growers including fertilizers, hydroponics, irrigation systems, lighting systems, and ventilation systems used in cultivating cannabis.

Scotts Miracle-Gro gave investors a dismal performance in 2018. However, it's important to consider the two primary reasons behind Scotts' big decline.

First, colder weather hung around longer than normal in the first several months of 2018. That hurt Scotts' core consumer lawn and garden business, which generates around 87% of total revenue. Second, as mentioned earlier, California's legal recreational marijuana market was derailed by exorbitant tax rates and crippling bureaucratic regulations. These problems prompted Scotts Miracle-Gro CEO Jim Hagedorn to state bluntly that "if you ever want to see how politicians can screw something up," look at California. 

But both of these problems are only temporary. Climate experts predict warmer weather is on the way. And things are improving in California's recreational marijuana market. Scotts Miracle-Gro's beaten-down share price actually contributes to making the stock a safer play looking ahead.

Like Constellation Brands, though, Scotts' primary advantage in terms of relative safety is its core business. The company has plenty of growth opportunities by launching new consumer lawn and garden products, particularly craft brands and organic brands. While investors wait on the stock to bounce back, Scotts shares another thing in common with Constellation Brands that should help: a dividend. Scotts' dividend currently yields nearly 3.5%.

4. Innovative Industrial Properties

Innovative Industrial Properties is a real estate investment trust that specializes in the medical marijuana industry. A REIT allows investors to pool their money to own real estate properties and it has a unique distinction that provides some safety for investors: REITs are required to distribute at least 90% of taxable income to shareholders as dividends.

The REIT dividend rule can better insulate investors from the risk of investing in the volatile marijuana industry. The company's dividend currently yields 2.7%. If the stock fell by 2%, investors would still enjoy a positive (albeit small) overall return thanks to the dividend payment. A stock that didn't pay a dividend and fell by the same amount would provide a loss rather than a gain. It's a small cushion -- but a cushion nonetheless.

However, the more important reason why Innovative Industrial Properties ranks as a relatively safe marijuana stock is that its risk is diversified more than most other marijuana stocks. The company currently owns 10 properties in eight U.S. states. Each of these properties is leased to a tenant operating in the medical marijuana industry. Even if one or two of Innovative Industrial Properties' tenants went out of business, it wouldn't be catastrophic for the company.

Also, unlike many marijuana businesses, Innovative Industrial Properties is profitable and has zero debt. Companies that are profitable and have no debt have much greater financial stability than those that don't. It certainly doesn't hurt the relative safety profile for Innovative Industrial Properties that the company operates in states with marijuana markets that should grow significantly. Four of the states where Innovative Industrial Properties owns and leases properties are expected to have marijuana markets of $1.2 billion or more by 2022.

5. KushCo Holdings

KushCo Holdings ranks as the top provider of packaging for the U.S. cannabis industry. The company supplies a wide variety of packaging solutions specifically designed for cannabis products, including pop-top bottles, vaporizer cartridges, and tubes. 

But KushCo has also ventured beyond its core business and geography. The company acquired Summit Innovations in May 2018. This deal gave KushCo a new focus on supplying hydrocarbons and solvents for the extraction process used in producing cannabis edibles, oils, and waxes. This is a potentially lucrative market because of the tremendous growth in the use of cannabis waxes in vaporizers and the premium prices that cannabis oils can command compared to dried flower. KushCo also bought creative agency The Hybrid Creative, which offers brand strategy, design and marketing, web application development, and e-commerce solutions to clients in the U.S., Canada, and Europe.

So what makes KushCo a relatively safe marijuana stock? Its diversification. The company has more than 700 corporate customers, none of which generate more than 10% of KushCo's total revenue. KushCo's expansion into supply hydrocarbons and solvents and creative services adds to its product diversification. 

The rapid growth in the U.S. marijuana industry should give KushCo plenty of room to run. Total U.S. marijuana sales are projected to reach more than $22 billion by 2022 -- over double the estimated sales level for 2018. KushCo's large product library, close relationships with marijuana businesses, and knowledge of the regulatory environment in the U.S. give the company a competitive advantage that should be sustainable. In addition, the company's stock isn't listed on a stock exchange that restricts where it operates, so KushCo can conduct business in the U.S. and anywhere else it chooses. 

Risks for these relatively safe stocks

Despite all the positives for Constellation Brands, Canopy Growth, Scotts Miracle-Gro, Innovative Industrial Properties, and KushCo Holdings, they all still face risks.  Some of these risks are common to all stocks. The threat of an economic recession is a key risk that could hurt the prospects of all five companies. Any company could also experience a loss of a key executive or a scandal involving an executive that causes its stock to take a hit.

But there are also risks specific to marijuana stocks, even the five relatively safe picks. All five companies either currently operate in the U.S. or hope to soon, so  setbacks in furthering revision of federal laws to allow states to control marijuana legalization could cause all of these stocks to fall. Further, any actions by the U.S. Department of Justice to prosecute marijuana businesses would likely be damaging to these marijuana stocks. 

For Constellation Brands and Scotts Miracle-Gro, there are risks to the companies' core businesses. Constellation, for example, could encounter heavier competition in the alcoholic beverages market. Scotts could experience another prolonged winter, hurting its sales of consumer lawn and garden products.

Because of these risks, even these relatively safe marijuana stocks might not be suitable for all investors. Even aggressive investors should exercise caution and not buy positions in marijuana stocks that are too great a percentage of their overall portfolios. Diversifying your portfolio beyond only marijuana stocks is one of the best ways to mitigate risk. For most investors, no more than 5% of your total portfolio should be in marijuana stocks.  

Some investors might prefer investing in marijuana exchange-traded funds, which own a basket of stocks but can be bought and sold like an individual stock. There are currently two marijuana ETFs: Horizons Marijuana Life Sciences ETF (NASDAQOTH:HMLSF) and ETFMG Alternative Harvest ETF (NYSEMKT:MJ). Investing in ETFs can lower risk levels since they provide diversification into multiple stocks. However, investors should note that marijuana ETFs come with their own significant risks, notably including high expense ratios (fees associated with managing the ETF as a percentage of the amount invested), a heavy weighting of stocks with especially high valuations, and limited exposure to the U.S. -- the largest marijuana market in the world. 

What to look for in 2019

While there are risks and potential volatility ahead, 2019 should be a pretty good year for each of the stocks mentioned. Momentum in the Canadian recreational marijuana market could benefit Canopy Growth and Constellation Brands, especially as regulations are finalized for cannabis edibles (including cannabis-infused beverages) and concentrates. New markets in the U.S. resulting from states that voted in 2018 to legalize marijuana could help Scotts Miracle-Gro, Innovative Industrial Properties, and KushCo. The U.S. legalization of hemp, which, as mentioned earlier, is cannabis containing low levels of THC, could potentially provide a boost to several of these stocks.

Having a possibility of solid returns requires taking on some risk. The good news about Constellation Brands, Canopy Growth, Scotts Miracle-Gro, Innovative Industrial Partners, and KushCo Holdings is that their risk-reward propositions look more favorable than most marijuana stocks.

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