Could the Marijuana Bubble Burst in 2018?

Could pot stocks like Canopy Growth Corp. (TSX:WEED) stand to lose more than 50% this year? That’s a possibility, here’s why.

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Like it or not, pot stocks aren’t investments right now. They’re a speculation that some pundits would take a step further by claiming that the industry is in a bubble that may be on the verge of popping. Over the last few years, we’ve seen several many booms and busts. Deep corrections that are usually dwarfed by massive rallies that made speculators very rich over a very short period.

If you’ve doubled, tripled, quadrupled or even quintupled up over the course of a few months, it’s a pretty wise decision to at least take your original principal off the table so that if marijuana is, in fact, a bubble, you won’t end up losing your shirt when all is said and done.

Unfortunately, greed and euphoria drive many smart investors to double-down on their holdings after they’ve already made a fortune.

Sir Isaac Newton, a genius by anybody’s standards, spiralled into financial ruin by upping his bet in the “marijuana stock” of his day, the South Sea bubble. Of course, he took his profits after he made a great deal, but the continued rise in shares after he initially sold made brought out his FOMO (fear of missing out) mentality. It’s human psychology and at the time, nobody really knew that the bubble would ever pop the way it did.

The current state of the marijuana industry certainly draws some comparisons to the South Sea bubble when it was in the new paradigm phase. The “opportunity of a lifetime” has become mainstream and many speculators in the general public have already placed their bets without a care of the prices they’re paying.

Making money off pot stocks just got a whole lot harder

As we inch closer to legalization day, there’s no question that stakes have been raised, but whether the sky-high expectations can be reached in a post-legalization environment remains to be seen. Although pot stocks have corrected yet again this year, another triple-up rally is not guaranteed, especially since nobody can properly see past the haze of marijuana smoke that lies ahead. Forget about where pot stocks will be in a year from now, it’s nearly impossible to predict where they’ll be tomorrow with the off-the-charts volatility that’s become the norm.

Analyst projections for individual pot firms are all across the board. You’re essentially throwing darts and yes, some analysts will hit the bull’s eye, but a majority of them will likely fail to hit the board! As such, I’d encourage long-term investors to avoid marijuana stocks until after a potentially catastrophic collapse that may be triggered by unforeseen consequences that could derail the investment thesis entirely along with the opportunity from nationwide legalization.

If you’re willing to speculate on pot stocks within your mad money portfolio (money you’re willing to part with), I’d stick with Canopy Growth Corp. (TSX:WEED), as the company has not been reckless when it comes to aggressive M&A activities at a time when valuations are off the charts. Canopy CEO Bruce Linton slammed the recent acquisition activities conducted by industry peers by stating they’re “paying a dollar to buy a dime.” At sky-high valuations, Canopy’s sit-and-wait approach definitely leads me to believe that its stock has less downside versus peers that have been active on the M&A front recently.

Although Canopy appears to be a more calculated firm that’s not rushing to pull the trigger on deals while severely diluting shareholders in the process, no pot stocks will be a safe place to hide should the broader industry collapse. Will it happen in 2018? Nobody knows, but if the thought makes you sick to your stomach, then maybe it’s time to avoid pot stocks altogether and only bet what you can afford to lose.

Thus, I’d tread carefully if you’re thinking about placing a bet on pot stocks since nothing but perfection will be expected once the first round of post-legalization quarters are released.

Stay hungry. Stay Foolish.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette has no position in any of the stocks mentioned.

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