Cannabis-sector volatility highlights need for investors to be wary of stock scams

Former business reporter David Baines weighs in on ways investors can protect themselves

Investors are wise to scrutinize management, corporate share structures and the total number of shares outstanding | Lumppini / Shutterstock

Some of the companies researching cannabinoid-infused drinks are ventures within the broader cannabis subsector that have flown high in recent months but have also had bouts of extreme volatility.

Increased investor interest in the space has resulted in many companies shifting business models to the cannabis industry, issuing more press releases and going public via reverse takeovers – a situation that should increase investor vigilance about researching which companies merit investment consideration.

Hysteria started to ramp up after Molson Coors Brewing Co. (NYSE:TAP) announced August 1 that its Canadian division would form a joint venture with Ontario’s Hydropothecary Corp. (TSX:HEXO) to produce non-alcoholic, cannabis-infused beverages.

Constellation Brands Inc. (NYSE:STZ), perhaps best known for its Corona beer brand, then helped stoke cannabis-stock fever by announcing a $5 billion followup investment in Canopy Growth Corp. (TSX:WEED; NYSE:CPG) on August 15. Canopy’s shares surged more than 117% between August 14 and September 25.

Other companies’ shares jumped in tandem as investors speculated about which other large-beverage-company investments could follow.

Nanaimo’s Tilray (Nasdaq:TLRY) had the wildest ride of them all. It was the talk of Wall Street on September 19 when it soared 93.5% to an intraday high of US$300, before falling back to close at US$214.06. That put Tilray’s market capitalization at more than US$19 billion – a valuation 1,159% more than when the company went public two months earlier at US$17 per share. Three trading days later, Tilray’s shares closed at US$99.50.

Similar feeding frenzies have occurred through the decades. Most recent was last year’s run-up for cryptocurrency stocks. The late 1990s dot-com boom and bust is another example of rapidly rising share prices followed by a steep fall.

Former business reporter David Baines, who won many Jack Webster awards during his decades with the Vancouver Sun, recalls that a similar surge took place on what was then the Vancouver Stock Exchange in the mid-1990s.

“Dia Met Minerals made a spectacular diamond find in the Northwest Territories, which caused a huge staking rush with dozens of satellite companies staking adjacent claims and offering the prospect of more riches,” Baines told Business in Vancouver. “Of course, most of them failed. This is now happening with cannabis. If history repeats itself – and it will – most of these marginal players will fail.”

Baines warns retail investors to pursue research and focus in particular on three elements: management, corporate share structure and the number of shares outstanding.

Researching management can pay off because sometimes promoters have a spotty track record that could include setting themselves up with cheap stock, hyping the company and then blowing off their stock, Baines said.

“Share structure is another critical aspect. Who has the controlling interest? How much did they pay for their stock? If the company raised money through the private sale of stock, who got those shares and at what price?”

Baines remembers cases where promoters sold cheap shares to friends and associates who acted in concert with the insiders. That often includes buyers in offshore tax and secrecy havens, he added.

“Most importantly, investors have to look at how many shares are outstanding. You also have to look at how many options and warrants are out there, and their conversion prices. If they are convertible to shares at, say, $0.50 each, and the stock goes to $1, there is a high likelihood they will be converted to shares and sold into the market, which can seriously depress the stock price.”