Ask Our Experts 08/05/2018

Q: I currently have 14 different stocks, but they’re all penny stocks ($0.01 to $0.35 a share); what is your recommendation for more of these, and am I investing in the wrong place?

A:
Investing in penny stocks is one among many investment strategies to gain exposure to the burgeoning cannabis industry. As investors look to profit from the sector’s steady rise, and gain exposure to the upside potential by investing in penny stocks, there are several things to keep in mind.

Investors should always consider potential risks and opportunities when selecting individual penny stock companies. It is also prudent to establish investment goals and risk tolerance throughout the individual selection process.

Risks of investing in penny stocks with small market caps and small stock prices between a penny to $0.35 will be higher than investing in some of the bigger, more established companies. Larger companies tend to be more stable, and thus may have larger stakes in the industry. Additionally, traded penny stocks often face less stringent reporting requirements and regulatory oversight, which can increase the risk to investors. Investing in bigger cannabis-related companies is another strategy for profiting from the industry while reducing risk, though the returns from larger companies may not be as high as the micro-cap companies.

Particularly when investing in cannabis-related companies, responsible investors need consider the potential risks and high relative volatility caused by regulation changes and other sector developments. Such uncertainty can lead to significant price swings in the short term. As part of risk assessment, investors should determine their exit strategy for each company in advance so as to reduce exposure to volatility. Again, as penny stocks tend to be more volatile than larger companies, they are an inherently riskier investment (though often yielding higher returns than lower-risk assets). Investing in larger companies within the industry can help protect against any downside swings from volatility.

Investors may want to consider companies with strong revenue and earnings to determine whether a given company is on a path toward growth and profitability. It is important to understand each company’s business model during the selection process and critically assess whether the strategy and its implementation are realistic and achievable. Evaluating the potential growth of a company within its sector or segment of the industry is also important: Along with studying a company’s potential M&A activity, accessing specific sector or segment performance along with its growth trajectory should be part of the equation for stock selection.

As the cannabis industry continues through the expansion phase of the business cycle, smaller companies will have the potential to outperform larger companies. Penny stocks are vehicles for high-risk, high-reward types of investment, and as the market matures and stabilizes, there will be less of the volatility that has made cannabis penny stocks so attractive to many short-term investors. However, investors seeking assets that they can hold for the medium- to long-term outlooks must be judicious in their evaluation criteria and selection process, and they ought carefully monitor the performance of the companies in which they invest.

Disclaimer: New Frontier Data is not a liable party as it is not a licensed financial advisor.