A call to caution with pot stocks

While fundamentals and technical analysis are an important part of stock prices, so too is human behaviour—a point emphasized in a market insight report from Richardson GMP that outlines the rise of pot stocks and compares it to past market exuberance.

“Fundamentals tend to play out and are the driving force of long-term results, [and] technical analysis can help you manage the turn, but flow in human behaviour can dominate all else and drive prices far beyond rational explanation,” says the report.

In particular, prices reach over-extended levels because of irrational exuberance, a term coined by Nobel laureate Robert Shiller, which is predicated on a positive feedback loop.

“Feedback loops and other behavioural mistakes are critical components in every bubble in history,” says the report.

As such, caution is warranted with pot stocks.

“Share prices for cannabis companies are not based on fundamentals,” says the report. For example, large players are “working hard trying to capitalize on the hype,” it says. The report refers to meetings with two of the largest names in the space, both of which are working to get listed in the U.S. to expand investor reach—something that will fuel the feedback loop.

While the firm expects the cannabis market to expand, growth expectations likely don’t justify current valuations, which are “off the charts using any typical metrics,” it says. Dilution is also a concern as new stock is issued at high valuations, the report adds.

“Investors always overestimate the impact of the next big thing,” says the report, comparing cannabis’ market evolution with that of 3D printing. “Big companies in the [3D printing] space that got swept up in the mania are likely never going to reach their previously lofty heights.”

While it’s anyone’s guess how long the lofty heights of pot stock valuations will last, “eventually, the smoke will dissipate, and reddish eyes will look back and wonder how they failed to see the signs,” says the report.

For full details, read the Richardson GMP report.