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Marijuana stocks undergo buying spree as investors pin hopes on legalization

Publicly traded pot stocks have soared to record highs in recent months as the Liberal government moves ahead with its promise to legalize marijuana for recreational use, leaving investors wondering if all of the gains are already baked in.

The legislation isn't expected until the spring of 2017, with sales potentially starting in 2018, but many stocks in the emerging sector have more than doubled – and then some – since the Liberals won the election around this time last year.

While some investors caution marijuana is a highly speculative market with huge risks, including that the legislation doesn't go through, others are confident there's a lot of money yet to be made in a sector gaining greater societal acceptance.

"We see rapid growth if and when a recreational market comes into Canada," says PI Financial analyst Jason Zandberg.

Mr. Zandberg's forecast is for Canada's total pot industry – medical and recreational combined – to reach $4.6-billion in its first year. That's up from the current medical-only market currently estimated at about $150-million. He also expects the combined market to grow 10 per cent annually to $7.4-billion in the first five years. As a comparison, Canadians spent $8.7-billion on beer in 2014, according to Statistics Canada.

The biggest gainers are expected to be licensed producers, or LPs, that already have Health Canada approval to sell marijuana for medical use, including publicly traded companies such as Aphria Inc., Canopy Growth Corp., Mettrum Health Inc., and OrganiGram Holdings Inc. Mr. Zandberg has a "buy" and "speculative risk" rating on all four of these stocks he covers. There are currently 10 publicly listed pot stocks based in Canada today (MMJ Phytotech, now traded in Australia, is seeking a Canadian listing).

In August, GMP Securities analyst Martin Landry wrote in a note that publicly traded LPs "have only begun reflecting the [approximately] 12 times increase in market size" he expects in the next six-to-seven years.

"We believe that as we approach the opening of the recreational market, licensed producers' stock valuations should move upward to reflect this large opportunity," Mr. Landry said in the note. He covers the same four stocks as Mr. Zandberg, and has a "buy" on each.

He describes the nascent industry as a "rare and unique opportunity" for investors, given that LPs are tapping into an established multibillion-dollar market at a time when public perception about use of the substance is changing.

Not only is the Liberal government poised to "legalize, regulate and restrict access to marijuana," but more groups – from veterans to construction workers – are endorsing and signing deals with marijuana producers. Last month, for example, Mettrum struck a supply agreement with Cannabis Care Canada Inc., which is backed by the Laborers International Union of North America, the single largest construction union in Canada and the United States with more than 100,000 members.

"There are only so many ways to play the space," says Dundee Capital Markets analyst Daniel Pearlstein, who covers five of the larger public producers (Aphria, Canopy Growth, Mettrum Health, OrganiGram and Supreme Pharma).

Mr. Pearlstein says investors "should be positioning themselves ahead of the [federal] task force update expected in November." The task force was launched in June to help set the rules for a potential new recreational pot market in Canada, including how recreational marijuana will be sold and taxed, what the purchase limits will be and penalties for improper possession.

It's these lingering questions about what the market would look like that has some calling for extreme caution when investing in marijuana stocks right now, especially given the recent runup in prices.

"What if the government doesn't pass the legislation? All of these stocks are going to get creamed," says Peter Imhof, vice-president and portfolio manager at AGF Investments.

He bought Aphria a couple of years ago on a financing, and has tripled his money since, but has no plans to buy more stocks in the sector right now.

For investors willing to take the risk, Mr. Imhof suggests looking at factors such as the number of prescriptions the companies currently fill in the medical market, their ability to grow a good product at a low cost and the experience of the management team behind the company.

"It's a hot sector, so a lot of new people are coming into it," he says.

Ryan Modesto, managing partner at independent research company 5i Research, recommends investors steer clear of pot stocks, which he says are "aggressively" priced on the potential of a retail market that doesn't yet exist.

"Our big issue is that it's hard to call the marijuana industry an investment at this point in time. We think it's more speculative than anything," Mr. Modesto says.

Still, he doesn't deny investors could still make money in the near term.

"But that's speculation, not necessarily investing," Mr. Modesto says.

Publicly traded marijuana companies

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