All investments come with some amount of risk. Generally, the higher the potential return of an investment, the higher the risk. There is no guarantee that you will actually get a higher return by accepting more risk. Learn more about the risk-return relationship.
When you invest in the cannabis industry, you’re exposed to different types of risk that can affect your potential return. Some common risks include:
No guarantee of success
Despite the rapid growth of companies in the cannabis sector, there remains no guarantee that their businesses are profitable or will be in the future. Many cannabis companies are hedging their success on the future distribution and sale of their product, despite the fact that many rules and regulations around distribution and sale are still in the process of being established.
Some early medical cannabis companies were not successful, with some often failing to provide investors with adequate disclosure about the barriers to entering the industry (such as licenses required to grow cannabis) and other work needed to create a profitable business. While these disclosure requirements have been addressed by Canadian securities regulators, the risks of investing in this emerging industry still remain. As with any investment, there is no guarantee that an investment in the cannabis industry will provide any return or income.
The governments and regulators in many of the jurisdictions that are exploring new cannabis laws have yet to fully establish the framework for how and where cannabis products can be sold. For example, there may be some restrictions on the stores that are permitted to sell cannabis, as well as rules about branding and advertising that could affect a consumer’s ability to find and purchase products. These sorts of challenges can affect a company’s ability to sell its products and make a profit, which in turn could reduce the value of your investment in the company.
As regulation continues to evolve and the cannabis industry grows, new companies will enter the industry and compete with existing cannabis businesses. Increased competition may compel a company you have invested in to adjust its business model, adjust the prices of its products, or make other changes in order to stay competitive. This may affect the value of your investment.
Cannabis companies must abide by all the laws and regulations of the jurisdictions in which they operate, which can vary from country to country. Should laws change, the company may be required to adjust its operations to comply with the law or risk having legal action taken against it. In some cases, this may mean ending its business.
In the U.S., some states have authorized the sale and use of cannabis, but it still remains illegal under federal law. Authorities in the U.S. could choose to enforce federal law at any time, putting any company with cannabis-related activities in any U.S. state at risk of being prosecuted and having its assets seized.
Investing in a company that does business in a place where the law either prohibits cannabis or is unclear about its use puts your money at risk. If legal action is taken against a company in which you have invested, you could stand to lose your entire investment.
While laws and regulations around the sale and use of cannabis in Canada are changing, there are still a number of rules in place to guide the way that cannabis companies operate. If a business does not comply with these rules, it could have legal action taken against it and you could stand to lose your investment.
Pricing and taxation
Government-mandated pricing and taxation on cannabis products may also pose a risk to the success of a cannabis company. Cannabis products, especially those intended for recreational use, should be priced below their black-market value in order to attract consumers. If the government prices cannabis products too high, or if black market dealers undercut prices of products available in stores, the companies growing and selling the products may not be able to sell enough product to make a profit.
Inflated share prices
Opportunities to invest in new cannabis companies or existing companies expanding their business into the cannabis industry have generated a high level of interest among investors looking to get in on a new trend with the expectation of quick growth. However, these investments can be highly speculative, and the cost of an investment in a cannabis company may be based on the expectation of its future success rather than its current performance.
In some cases, companies that have simply announced their intent to develop a cannabis business have seen an immediate rise in their stock price, before there is even a viable business in place. Investors who buy shares in these companies risk paying an inflated price for an investment that may never increase in value.
As the popularity for cannabis-related products grows, companies have to scale up their operations to meet the demand, which may include building larger facilities, buying additional equipment and hiring additional employees. This can cost considerable amounts of money, and if a company doesn’t have the funds required to expand its operations, it may choose to raise money by issuing additional shares.
When companies issue additional shares to raise money, it comes at the expense of existing shareholders, whose percentage ownership decreases proportionally to the number of new shares created. This is known as dilution. If you hold shares in a company that continuously raises money by issuing more shares, your investment will decrease in value.
High operating costs
The costs associated with developing and operating a commercial cannabis company can be considerable. Growing and selling cannabis requires specialized and large-scale agriculture facilities and enormous amounts of power and capital in order to operate. Construction and energy costs can greatly increase a company’s overhead, and as companies scale up in order to meet demand, the costs of constructing new buildings may undercut profitability, especially if there are significant cost overruns or construction delays that impact a company’s ability to produce and deliver its product.
As an investor, you should understand the company’s business plan and how it intends to earn a profit, as well as the related risks, costs of doing business and time it may take for the business to become profitable. There is no guarantee that a company will be successful in generating profitsProfits A financial gain for a person or company. Equals the money left over after you subtract your costs from the money you made.+ read full definition or increasing its stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition value.
Read the full article: Investing in the cannabis industry