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  • Cannabis stocks are trading significantly below their highs.
  • Leaders in marijuana are emerging, and maturing operations offer an opportunity for margin expansion as revenue increases.
  • Tailwinds from further marijuana legalization, including potential changes to Federal laws, support the industry.

The marijuana market is massive, and legal marijuana companies are rapidly displacing black market operators. But, unfortunately, that's cold comfort to cannabis stock investors. After an eye-popping, bubble-building run-up a few years ago, most marijuana stocks have tumbled, leaving many investors under water.

For example, Canopy Growth  (CGC) , one of investors' favorite cannabis stocks in 2018, has fallen from $57 in 2018 to below $4 today. In addition, the popular ETFMG Alternative Harvest ETF  (MJ)  is down 87% from its 2018 peak. More recently, AdvisorShares Pure US Cannabis ETF  (MSOS) , which focuses on U.S. marijuana stocks, including multi-state operators, has fallen 78% since February 2021. That's not very encouraging.

Are cannabis stocks a buy?

Nevertheless, Real Money Pro's Doug Kass thinks better days are coming. This week, he said he plans to "substantially" increase his exposure to marijuana stocks in the coming days. Kass lists ten reasons to be optimistic about the industry, which I include below in its entirety.

Kass writes:

"I plan to substantially raise my cannabis holdings in the days ahead.

The reasons are multiple so Let's get Chai!

1. Price-to-sales ratios have gradually dropped from over 4x-5x to between 1x-2x as analysts, holders and management have become more realistic in their industry growth expectations.

2. State-by-state legislation continues apace.

3. As the larger multi-state operators, with reasonable balance sheets, enter new states, they are establishing deeper competitive moats against poorly financed competitors.

4. With a growing number of states permitting recreational use of cannabis it seems to me that federal legislation is inevitable.

5. With an increased and improving probability of federal legislation, SAFE banking -- uplisting, et al. -- also seems likely.

6. Along with SAFE will be an alleviation of custody issues that have prevented "plain vanilla" institutions from owning cannabis equities.

7. Sentiment could not be worse after -75%+ drawdowns over the last two years.

8. According to my calculus, and at current levels, the upside reward is compelling and dwarfs the downside risk.

9. As previously noted, a naked shorting ban in Canada-listed stocks was instituted last week.

10. ETFMG Alternative Harvest ETF (MJ) will begin including U.S. MSOs next week.

My holdings include AdvisorShares Pure US Cannabis ETF (MSOS), Cresco Labs  (CRLBF) , Trulieve Cannabis  (TCNNF) , Green Thumb Industries  (GTBIF) , Verano Holdings  (VRNOF) , Ayr Wellness  (AYRWF) , TerrAscend Corp.  (TRSSF) , and Tilray  (TLRY) .

The Smart Play

In the early days of a significant disruption, animal spirits can inflate valuation to unsustainable levels. Indeed, that's what happened here. However, now that the market is maturing and leaders are emerging, investors may be able to find some bargains on the discount rack.

While some states have yet to give the thumbs up to recreational use, such as Florida and Texas, most states have either fully legalized marijuana or legalized it for medical use. Marijuana growers and retailers within states where it's legal have already built significant infrastructure. Learnings from their initial operations should offer them opportunities to maximize profitability from here, especially if rising revenue results in operating leverage.

According to Cowen, the total addressable market for cannabis will reach $28.3 billion this year and climb to $46.2 billion in 2026.

If you're interested in tucking marijuana stocks into your portfolio, consider starting with the companies Kass lists above. After all, he's already done the heavy lifting evaluating them. However, the AdvisorShares Pure US Cannabis ETF (MSOS) is another option if you're less comfortable with single stock exposure to the industry. It owns over 40 companies in the U.S. marijuana market, and its 0.73% expense ratio is pretty reasonable for a niche ETF.

If you buy, keep exposure limited to what you usually allocate to a high-risk investment. Although these companies are beaten down, they could still go lower if regulatory winds shift. For this reason, use stops to protect yourself from outsized losses.

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