On Thursday, we saw pot stocks drop more than 10%, as we continue to see a big correction take place in the industry. Canopy Growth Corp. (TSX:WEED) has declined more than 7% year to date, which is a big drop for a stock that produced returns of more than 225% last year. However, it’s not the only one off to a bad start, and there’s reason to believe that more declines could be on the way.
Aphria Inc. (TSX:APH) is down a whopping 17% in 2018, while MedReleaf Corp. (TSX:LEAF) is down as much as 18%. Aurora Cannabis Inc. (TSX:ACB), however, has been able to achieve a modest 6% return since the start of the year after it reached a friendly deal to acquire Cannimed Therapeutics Inc. (TSX:CMED).
What’s behind all the selling?
It’s not just pot stocks that are down. The TSX has declined 2% and has dropped below 16,000 for the first time since early December. The once unstoppable cryptocurrency, Bitcoin, has also declined more than 30%, as investors have been selling off their speculative buys.
Recent acquisitions in the cannabis industry have likely attracted investors’ attention as well, and that may have called into question the sky-high valuations that we’ve been seeing for some time now. While Aphria may have paid a significant amount for its latest acquisition, and Aurora also placed a high value for a company with just $15 million in sales, but the problem is that is just par for the course in an industry where valuations have ignored any and all logic.
Investors may finally be opening their eyes to these high values and have decided to sell their holdings to secure gains before a bigger correction comes around the corner.
Why more of a decline could be coming
Even after the big sell-off of Canopy, the stock is still trading at a price-to-sales ratio of more than 90. If investors are taking a closer look at valuations, then it could be a dangerous time to be holding pot stocks. You’ll be hard-pressed to find stocks trading at higher premiums than what cannabis stocks are currently going for.
Marijuana stocks have been very reactive to news and developments in the industry, and if we see a delay in the legalization of pot or any sort of hiccups along the way, the sell-off could quickly turn into a crash.
What’s an investor to do?
Investors would be well-advised to look for stocks with good fundamentals that aren’t built off hype. This is the best way to ensure that you’re not exposing yourself to the risk of a big market correction, especially if you’re paying a big premium for a stock. If you’re invested in a company that has strong fundamentals, at least you know the stock is still a good buy.
While safe, blue-chip stocks might not offer you astronomical returns in a short amount of time, you won’t have to ride the roller coaster either.
Marijuana stocks could very well recover from this recent sell-off, and there could be an opportunity to still make some strong, short-term gains. However, these are not investments I would hold for the long term.
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Fool contributor David Jagielski has no position in any of the stocks mentioned.