So far in 2019, cannabis stocks have been on a roller coaster ride. Investors are wondering which marijuana companies may be better investments for the long term. If you are interested in buying into marijuana shares, you may also want to take a closer look at the ETFMG Alternative Harvest ETF (NYSEARCA:MJ). The MJ ETF is a marijuana ETF that has about $1 billion in assets under management.
Investing in the MJ ETF may enable investors to take a long-term view on a growth industry that is likely to reach tens of billions globally in a decade or two. However, investors in the cannabis sector should also remember how choppy individual stock prices that make up the MJ ETF can be.
Mechanics of Investing in the MJ ETF
Investors may be able to decrease the volatility of investing in individual stocks by holding more of them, or better yet, investing in an ETF. And at InvestorPlace, my colleagues often cover how various ETFs can help investors construct a diversified portfolio.
Similarly, MJ seeks to provide investment results that correspond to the total return performance of the Prime Alternative Harvest Index. This index tracks the performance of U.S. and global companies that are engaged exclusively in legal activities involving cannabis for medical or non-medical purposes.
MJ’s expense ratio is 0.75% per year or $75 annually per $10,000 invested. For many investors, the comfort in owning a basket of stocks might be worth the price.
While the MJ ETF is still exposed to the industry risk, it may provide a good option for investors, as it is will likely be more stable than owning some of the individual stocks. Before investing in marijuana stocks, though, it is important to do your due diligence on the MJ ETF.
Companies in the MJ ETF
Canada is the second country in the world — after Uruguay — to legalize recreational marijuana at the federal level. Since then, a number of federally licensed Canadian cannabis producers have started trading on the Toronto Stock Exchange (TSE) as well as the New York Stock Exchange (NYSE).
The MJ ETF currently holds 38 stocks with about 70% allocation to pot companies and growers, many of which are Canada-based and that are becoming increasingly mainstream. Several of the major stocks in the MJ ETF include Aurora Cannabis (NYSE:ACB), Cronos Group (NASDAQ:CRON), GW Pharmaceuticals (NASDAQ:GWPH), Canopy Growth (NYSE:CGC), Tilray (NASDAQ:TLRY) and Green Organic Dutchman Holdings (OTCMKTS:TGODF) It also has an allocation of tobacco stocks and fertilizer companies. The top 10 holdings represent about 60% of holdings in the MJ ETF.
One fundamental point that investors need to keep in mind is that most of these cannabis producer stocks are not profitable yet. Analysts value them mostly based on the expectation of high revenue growth, which would lead to future profits. Therefore, whenever Wall Street fears the given company is failing to meet growth or expectations, that pot stock will get penalized.
While MJ can avoid some of the bad performances of most marijuana stocks, it would be difficult for it to outperform several of its large holdings, such as Cronos Group, Aurora Cannabis and Canopy Growth. Nonetheless, the level of diversification helps make the MJ ETF more robust than any individual stock in the sector, limiting volatility and downside while retaining the exposure to the market’s potential upside.
Cannabis Industry in Canada is Still in the Early Innings
The lure of higher-than-average returns may be tempting for many pot stock investors. After all, early investors in many of these stocks have been rewarded handsomely.
But as the cannabis industry in Canada matures, will the fundamental forces allow for high double-digit returns any more?
The recent earnings reports from Canada-based pot stocks are important in gauging the health of the industry. At present, not everyone is convinced that Canadian recreational pot sales will remain strong. Many investors are concerned that the initial hype surrounding the industry could be decreasing.
Since legalization in October 2018, Canadian sales numbers have been muted without any signs of increasing. In 2019, the total cannabis market in Canada, including both legal and illegal recreational and medical sales, is expected to be around $7.2 billion CAD. About half of it is likely to come from legal sales. The Canadian market may also be running the risk of being oversupplied.
Is all this capacity truly needed, given that export volumes are not expected to meaningfully offset oversupply, either? If these marijuana companies harvest more than what they sell, there will be higher inventory balances. And simple economics tells us that a supply glut would eventually drive down the price of marijuana along with the margins of these companies. The developments in Canada over the past year has been reflected in the stock price of most of these Canada-based companies, moving investor sentiment from euphoria to greed to fear.
Marijuana is illegal in the U.S. at the federal level. However, at the state level, its legal status depends on the laws of the individual state. In other words, the legalized marijuana industry is still in its infancy, even in Canada, and it is almost non-existent globally. None of the Canadian marijuana stocks have so far done any business in these pot-friendly U.S. states, as the listing requirements at the NYSE or NASDAQ as well as at the Toronto Stock Exchange bar companies from engaging in commercial activities in countries where they would be breaking the U.S. federal law.
Where Is the MJ ETF Price Now?
In the past two years, marijuana stocks have been choppy and highly speculative. Their valuations can and do change suddenly and drastically, both as a result of event-driven company news or developments in the industry.
So far in 2019, with the exception of January, when many stocks did well, investors have witnessed considerable bearish activity in the industry. For most cannabis stocks as well as the MJ ETF, it hasn’t exactly been such a “hot” summer. And the value of this particular marijuana ETF reflects this volatility. Year-to-date, the MJ ETF is up 5%. After seeing an intraday low of $23.3 on Dec. 24, 2018, it has rallied to a high of $39.25 on March 19. Its 52-week high remains at $45.4, reached on Sep. 19, 2018. Currently it is hovering around $26.
Those investors who pay attention to technical charts should note that due to the decline in price since April, MJ ETF has a not-so-pretty technical picture. In the long run, MJ needs to build a base again before a long-term sustained leg up can occur.
From a price and time cycle perspective, the high reached on March 19, 2019, which came six months after the 52-week high of Sept. 19, 2018, is likely to be the highest price to be seen in the near-term. And MJ price may see a new 52-week low in Sept. 2019, possibly around $22.5, about a year after the current 52-week high of $45.4. Within the next month, I expect MJ to mostly range-trade between $27.5 and $25.
However, in case of a broader market selloff, similar to the one we have witnessed in the last quarter of 2018, the fund may easily go toward the low-$20’s level.
The Bottom Line on the MJ ETF
For most of the year, I have been bearish on most marijuana stocks. The hype that has led to high valuation levels, their mostly poor earnings and the dependency on the recreational aspects of cannabis make them risky and volatile investments.
Given the risk involved with investing in cannabis, no ETF holding pot stocks is going to be completely safe in being able to avoid losses, but MJ offers investors some safety due to diversification.
Now that the sentiment has swung negative, contrarian investors may find value in the MJ ETF. However, investors still need to follow developments in the industry closely to evaluate the appropriateness for marijuana stocks for their portfolio.
It is important to note that unless legalization at the federal level in the U.S. happens, cannabis market is, for the most part, limited to the growth in Canada. And a limited Canadian market is not likely to help most of these pot stocks become profitable on an operating basis. This fact makes marijuana stock valuations even more difficult to justify.
Therefore, MJ investors should be ready for daily price fluctuations as well as high volatility around the earnings release dates of the marijuana stocks that mostly make up the ETF. Most of these Canada-based weed companies also have high operating expenses. And the red ink at the bottom of their income statements, quarter after quarter, is becoming a worry for shareholders. If the international cannabis market does not grow as expected, then MJ ETF’s price could also experience selling pressure.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.