As the United States slowly inches toward ending its ill-fated War on Drugs, first decriminalizing marijuana, we have begun to see the first attempts to build legitimate businesses around pot. With the legalization of marijuana in Colorado and Washington, the growth of medical marijuana in several states (including California), and the diffuse relaxation of penalties for pot-related crimes, many have recognized the enormous potential market for legal weed, especially if current trends continue. But a truly legitimate, sustainable industry is still years away. While a number of companies have recently staked their claims to the marijuana industry, nearly all of them are small-cap, high-risk junk investments.
Despite its legalization in Colorado and Washington, and for medical use elsewhere, marijuana is still a Schedule I drug under the Controlled Substances Act, and is therefore technically illegal throughout the United States (at a federal level). But the U.S. Department of Justice has declined to challenge the state legalization laws, and announced last year that it will refrain from aggressively enforcing federal laws in these states, with the understanding that said states will strictly regulate the production, distribution, and possession of marijuana. Yet these laws are still on the books, and can be enforced at the discretion of the DOJ and other federal agencies. This uncertainty has made any potential investment extremely risky, and has kept experienced investors, and companies, out of the industry (read how to minimize risk and maximize returns here).
Without capital from experienced investors and established companies entering the market, nearly all weed-based businesses involved in the marijuana industry are very small companies that trade as penny stocks: they generally have small market capitalization, are not listed on national exchanges, trade at fractions of a dollar (or even of a penny), and are highly volatile and illiquid. The combination of these factors makes penny stocks extremely risky investments. Many inexperienced investors are fooled by the low price and high volatility, and see penny stocks as an opportunity to get rich quickly by turning a small investment into a pile of cash. Such investors are often seen as easy prey for frauds and schemes such as “pump-and-dump,” in which the price is inflated and then sold by manipulators, leaving unsophisticated investors holding shares worth nothing (learn how to avoid investment scams here).
Add to this the novelty interest of investing in marijuana, and there exists the potential for a large number of inexperienced investors to lose large sums of money; and many already have. The roller coaster of marijuana penny stocks—made all the more crazed by recent SEC intervention — has already caused its share of losses. True, some investors have seen huge profits — but because these stocks aren’t listed on national exchanges, and have such low market capitalization, it is extremely difficult to sell large amounts without distorting the price (or the ask/bid ratio), meaning that these returns exist only on paper.
Putting money in penny stocks isn’t investing, it’s gambling. And it isn’t even the fun kind of gambling where you drink and smoke the night away playing poker or blackjack. No, it’s the sad, stale kind, where you put all your savings on thirty-one black, or buy an endless stream of scratch-off lotto cards, because no one ever explained statistics to you. No matter what the latest investment fad is, serious investors should avoid penny stocks and focus on real investments (see what our CEO has to say about smart investing here).