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By Joseph Morrison

We all see the advertisements on investing websites promising the unimaginable wealth that can be had by trading penny stocks. Penny stocks are alluring to retail investors because of the absurdly low price point and the seemingly limitless upside. After all, a stock that is trading at $0.08 has nowhere to go but up, right? Where this gets to be very dangerous is when there is a popular legislative event in a sector that is dominated by penny stocks.

The November elections included a few famous referendums on marijuana legislation. In both Washington and Colorado, laws were passed to legalize the recreational use of marijuana. This is in addition to the 18 states and Washington D.C. which has laws allowing for legal medicinal use of marijuana. This has thus created a lot of buzz surrounding stocks for firms which attempt to make profits from marijuana.

The first problem with marijuana stocks is that these are overwhelmingly penny stocks. Most of these stocks are not exchange traded and are not subject to the same filings to which most public companies are accountable. The underlying company for a penny stock can be on the verge of bankruptcy and an investor would never know it. Additionally, these stocks trade with absurdly low volume, therefore making these illiquid investments means that it is not easy to get out of a position since there are not many buyers. Where this can be particularly problematic is if a position is going against an investor and they wish to get out of it. The buyers are scarce to begin with and a marijuana stock going the wrong way on an investor will mean less buyers and therefore worse pricing to unwind a position if at all possible. I therefore urge investors not to play marijuana stocks at all until the market is there. We all want to get in ahead of everyone else and we all want windfall profits but until these stocks are more developed, I recommend to keep a watchful eye but stay away.

However, if an investor is thoroughly convinced that recreational marijuana is going to be a nationwide and perhaps worldwide phenomenon there are certain factors that the investor should look for. First, that the firm submits regular SEC filings. From these firms, look to see which firms have the best average trading volume and are therefore, hopefully the most liquid. Of the penny stocks that are considered marijuana stocks, only a small handful meets this criterion. The most liquid marijuana penny stock that has SEC filings is Mediswipe (MWIP.OB) followed up by Growlife (OTC:PHOT) and Cannabis Science (OTCQB:CBIS). All of these stocks have 3-month average daily volume over one million shares and have regular SEC filings.

Mediswipe is known as a marijuana stock because its prior name was Cannabis Medical Solutions though they are trying to expand to facilitate transactions across different medical segments, no longer just in marijuana. The firm's most recent 10-Q is gruesome at best. The current liabilities at $260,911 far exceed the current assets at $1,867. This company is hemorrhaging capital with a $330,388 net loss for the nine months ended September 30, 2012. In essence, this firm looks to me like it is headed out of business.

Growlife at least looks like it will remain a going concern since the current assets outweigh the current liabilities $610,719 to $560,564. This firm is also losing money at a rapid pace, however with a net loss of $849,707 for the nine months ended September 30, 2012. This is a firm which deals in indoor mini-greenhouses and also manufactures hydroponic gardening which is a popular marijuana growth method.

Cannabis Science is another firm that I view as having a tenuous future with liabilities outweighing assets $3,332,175 to $1,778,489. Additionally, the $14,096,204 net loss for the nine-months ending September 30, 2012 shows that this is also a firm which is bleeding out capital rapidly. This firm works in the medicinal space and is trying to create cannabis-based medicines to target a variety of diseases.

The thesis an investor generally has when looking to "hit the home run" with a marijuana penny stock is to buy it now and wait for the legislation to allow for recreational use and watch them all take off. Given the fundamentals of these firms, however and the glacial pace of legislation I question whether these companies will even be around if and when that day occurs. Again, I discourage purchasing any of these stocks.

The elephant in the marijuana space has been Medbox (OTCQB:MDBX) on the theory that this firm will be providing vending machines for people to buy their marijuana. There are no SEC filings to look at and this stock has very low volume so I do not recommend it on that basis alone. Anecdotally, I think back to cigarette vending machines which have vanished to the land of antiquity. To think that marijuana will have less regulation than tobacco products is slightly absurd and I would anticipate vending machines for cigarettes or merlot dispensers becoming more prevalent before I would hope for a growth opportunity in the marijuana vending space.

Looking over the grow fields of marijuana stocks paints a pretty grim picture in my opinion. However, some investors are still going to insist that this is the wave of the future and are willing to sit in a stock and wait for the legislation to come. If you are in this camp, I recommend firms which have a long history at growing controversial crops and have the marketing, lobbying, and supply chain pieces in place to actually capitalize on a real legalization campaign. Altria (NYSE:MO), Phillip Morris (NYSE:PM), and Reynolds American (NYSE:RAI) are examples of firms that are in far better positions to capitalize on any growth opportunities in the marijuana segment. I believe that if these tobacco firms see that the opportunities are starting to manifest in this segment, they will jump in and use their muscle to be the victors in this space.

If for nothing else, the people that are looking to get into these marijuana penny stocks should watch the big tobacco firms' movement in this area. If a firm is starting to push for legalization for recreational marijuana publicly, this is an indicator that the whole sector is preparing to take off. Until then, stay on the sidelines. You can't hit a home run if the ball is not thrown. The legislation in Washington and Colorado are just the pitcher taking the mound and by the time the pitch is thrown, your stock may be for a worthless company.

Source: Tokin' Penny Stocks: How To Play Marijuana Legislation If At All