Cannabis Stocks: REDUCE EXPOSURE NOW

I have been in this sector as an analyst and service provider through two businesses for more than a dozen years. The world is very excited right now about the potential for rescheduling cannabis, but the stocks have bounced too much on this "news" that isn't really news at all. On Friday night, after the markets had closed, the Wall Street Journal published a piece about President Trump considering rescheduling, and President Trump basically said that his administration is considering it at a press conference yesterday.

The President is considering it, and he could have a decision in a few weeks. President Biden surprised the world in late 2022 with an announcement that his administration was interested in rescheduling, and he pardoned a lot of people that had been convicted by the federal government for cannabis violations. In August of 2022, his Department of Health & Human Services instructed the DEA to reschedule cannabis, and on 4/30/24 the DEA said that it would do so. That never happened, though, as I discuss below.

Trump said during the elections that he favored rescheduling, but he has said or done nothing until yesterday in nine months since the election. In this piece, I explain what is going on and discuss why I think many cannabis stocks are up too much and are risky.

What Rescheduling of Cannabis Means

I have written a lot at New Cannabis Ventures about 280E taxation. I called ending it critical for the cannabis sector in late 2022 in a newsletter piece. 280E taxation was implemented during Reagan's presidency, and it compels cannabis growers or sellers to pay taxes on revenue less cost of goods (gross profits) rather than net income. It has been hammering the industry, much of which is struggling with high debt.

The law was written in the 80s to apply to anyone making money from illegal drugs, and it dictated that if these drugs were DEA Schedule 1 (cannabis, heroin, LSD) or Schedule 2 (cocaine, fentanyl), then the rule applied. If cannabis is rescheduled from Schedule 1 to Schedule 3, then the companies will pay income tax and not 280E taxes.

There is a lot more to rescheduling than just the taxation. It makes no sense to have cannabis treated as a Schedule 1 drug in my view, and rescheduling would lead to more research and less stigma. There is a movement by the Americans for Safe Access to have federally legal medical cannabis, which I think is smart and a good thing for the ultimate legalization of cannabis (like Canada did), and rescheduling could help this movement. Some talk about better banking access, though I am not sure. The fact is that all of the very large cannabis companies do have access to banking. Some suggest that the exchanges could start to allow the American cannabis operators to list, though this is uncertain. It would be a good thing.

Cannabis Stocks Have Soared

Cannabis stocks are still down year-to-date as measured by the New Cannabis Ventures Global Cannabis Stock Index, which closed yesterday at 6.57, down 4.5% from the 12/31/24 close. I believe that right now it is up almost 3% today, but it remains below the 6.88 year-end close.

Cannabis stocks have been beaten up badly since early 2021, when the index closed above 91! They have bounced a lot this month and this quarter. As of last night, the index had gained 23.5% in August and 30.9% since the end of June.

Many investors think only of American cannabis producers when they think about the sector, and the AdvisorShares Pure US Cannabis ETF (MSOS), which is currently at 4.79 with a high of 5.11 earlier today, is up now 25.7% year-to-date. It has climbed 69.3% in August.

So, cannabis stocks have moved sharply higher over the past few days and weeks.

My Cannabis Stock Outlook

If 280E goes away, it is good for the American cannabis companies, and they should go up. Of course, they may sell some stock to fix their balance sheets. 280E may not go away, and it is really bad for the American multi-state operators (MSOs) if it sticks around. Of course, we could get rescheduling and it could end up at Schedule 2 rather than Schedule 3, which would mean that 280E sticks around. We could also get a new tax imposed on the industry.

At 420 Investor, I run a model portfolio for my subscribers. I have been doing this a dozen years now, and my goal is to beat the Global Cannabis Stock Index. I typically don't have a lot of cash, but I do now. I am limited to a 20% cash maximum, and that is where I am now. Here is my current portfolio compared to the index as of last night:

I have been saying for a while now (years, in fact) that there is more to the market than MSOs. This week, I have cut my exposure to Canadian LPs a lot an am now very underweighted relative to the index. There is no reason for them to go up, and they have done very well. I exited my last MSO last week, before the news, but I am in no rush to buy them now, though some remain very cheap. I have a lot of Ancillary names in size (2X the index exposure) and in number (4 names out of the 6 in the model portfolio).

I think Ancillaries are the place to be, though I have taken profits on three positions over the past two days (and added the fourth today). These companies trade on the NASDAQ or NYSE already, they don't pay 280E taxation, and they have pretty good balance sheets. There should be a lot less downside to 280E sticking around. If 280E goes away, they should do better over time. These companies serve the cannabis operators, and a healthier customer will help them.

What Cannabis Stock Investors Should Do

Whether or not cannabis investors have profits or not, they should reduce exposure, especially to the MSOs. MSOS, the big ETF, has massive positions in the three largest MSOs, and I think two of them, Curaleaf (CURLF) and Trulieve (TCNNF), are quite risky at the current prices. Green Thumb Industries (GTBIF) is the third one. While I don't own it in my model portfolio, I do kind of like it due to its better balance sheet and its relative valuation. I have liked a few other MSOs, and I keep my eye on them. I would exit MSOS!

With respect to Canadian LPs, Organigram (OGI) reports tomorrow and is a reasonably large position of mine at 10.8% of the model portfolio. It filled the gap left behind in February today and is likely not a good addition right now. I would sell more if I could (20% max cash gets in the way!) I still have a small position in Tilray (TLRY), but it no longer makes sense in my view. It has tripled off the low and has moved up a lot since I upgraded it at Seeking Alpha earlier this month. My exposure is below the index exposure. I loved Village Farms (VFF), but it has soared and is at big risk of pulling back. 18 million $1.65 warrants were outstanding as of Friday.

On the ancillary, I wrote about Innovative Industrial Properties (IIPR) this weekend. I still like it, but I trimmed some today after the gap was filled. I also trimmed GrowGeneration (GRWG) as it approached 1X tangible book value and WM Technology (MAPS). I added another REIT, Chicago Atlantic Finance (REFI) today. I like IIPR more, but REFI trades just below tangible book value and, like all of these companies, is down year-to-date. If 280E taxation goes away, these four companies (and some others) should see more business.