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4 reasons your marijuana investment could end in tears

There’s no doubt the so-called pot stocks have been among the biggest stars of the ASX in recent times.

Stemcell United Ltd (ASX: SCU) rocketed up more than 3,000% in just one day, and those lucky enough to buy early and sell with the share price over the $1.00 mark have done well. Unfortunately, those buying at $1.00 have seen the share price smashed back to just 24.5 cents.

MMJ Phytotech Ltd (ASX: MMJ), Creso Pharma Ltd (ASX: CPH) have also seen their share prices jump more than 20% in just one day. For many investors expecting a 10% return on their holdings over a full year, that’s like Christmas come early.

MGC Pharmaceuticals Ltd (ASX: MXC) and Zelda Therapeutics Ltd (ASX: ZLD) are more than doubled in the past month alone, while Auscann Group Holdings Ltd (ASX: AC8) is up 200%.

There’s certainly plenty of potential for the marijuana hopefuls. Medicinal marijuana is tipped to be a huge new market, offering new types of pain relief to those patients who either can’t take the usual pain medications or those that find normal pain killers just don’t work for them. There’s also the legal marijuana market, with some states in the US fully legalising the drug and Canada expected to legalise it this year. According to some sources, the Canadian legal weed market is worth between C$15 and C25 billion a year.

Despite the potential, you won’t find me investing in these pot stocks. Here’s why.

Excessive valuations

All the ASX-listed pot stocks have very little or zero in the way of revenues or sales so far. Then they need to take off their costs. Whether any of them will be profitable is another thing entirely. Share prices can be extremely volatile so how do investors know what they are worth without earnings, and whether they should buy or sell?

Uncertain winners

There’s a Warren Buffett story that nicely encapsulates what’s going on with the marijuana market today.

Back in 1999, when talking about the tech bubble, Buffett asked his audience to imagine investing in cars in 1910. It was evident the sector was going to be a winner. But with hundreds of auto manufacturers, which one should they choose?

It was much easier to look at it from a different perspective. Instead of going long cars, the obvious trade was to short horses.

The same principle applies today. Even resources explorer Queensland Bauxite Ltd (ASX: QBL) is entering the marijuana sector, but does that mean the company will be one of the winners?

Politics

While Canada is expected to legalise recreational use of marijuana this year, there’s no certainty that the country will do that. And even if it does, there’s no guarantee that Canada could turn around and reverse its decision. That could effectively make Australian pot stocks worth zero. Australia may follow suit and legalise marijuana, but that may not happen for many years. How long can these companies survive if they can’t sell any product?

Safer bets

Given the huge risks, there are better ways of investing your capital in stocks that already produce profits, pay dividends and continue to grow earnings like these stocks below. While your fellow investors may have gone the boring route with lower-risk stocks, losing out big time with high-risk plays like these could see many investors leave the share market altogether.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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