This is the third article in my article series on Cannabis Stocks. I intend to dig through all of the listed investment opportunities in the cannabis industry.
SEC chose to halt trading in the shares of Growlife (OTCPK:PHOT) starting from last Thursday morning to 11:50 EDT April 24, 2014 "because of questions that have been raised about the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in PHOT's common stock."
The halt is the SEC's fifth trading halt of a stock related to the cannabis industry. The SEC has previously halted four other stocks, which are Citadel EFT (OTC:CDFT), Advanced Cannabis Solutions (OTCQB:CANN), Aventura Equities, Inc. (OTC:AVNE) and Petrotech (OTC:PTOG).
The sector scrutiny by the SEC has come following FINRA's warning about marijuana stock scams and a 'green rush' where we have seen triple digit performance by most marijuana related companies. The reason FINRA has put out the warning might be that the largest buyers of these stocks are inexperienced retail investors, who often in many cases lack either knowledge or resources to make thorough due diligence.
The big inexperienced retail investor interest in the marijuana industry has driven the valuations on most of these stocks up to a point that seem very similar to the valuations of the ".com concept stocks" during the .com bubble. For a reminder of how people were acting under the .com bubble, watch the documentary "Betting on the Market". The extreme valuation might also be due to the fact that fully diluted market caps of most of the medical marijuana stocks are higher than the one usually stated on financial websites. This is evident because most financial websites fail to include convertible debt, convertible preferred stocks, warrants and options into their calculations of market cap.
So, what the halts mean for the rest of the industry
The increased sector scrutiny has the potential of acting as a reality check for investors. This can start to remove some of the momentum in the rest of marijuana stocks, as the SEC might be cracking down on some of the other names in the industry.
The key for investors and traders is to avoid being caught long a stock that the SEC halts, as it usually has a negative effect on the stock price, as the following charts shows.
By the way, SEC halts shouldn't be a problem if you are a long-term investor and have done your homework.
How to avoid getting caught long stocks that the SEC halts
The easiest way to avoid getting caught long is to conduct thorough due diligence on the stocks that you buy. Thorough due diligence include reading through all of the SEC filings and searching the names of a company's executives, directors and business partners. By doing the two previously described things alone, it's usually easy to judge whether you should continue to research the company or not. With the worst of some of these stocks there are usually enough red flags in the SEC filings and backgrounds of its executives, officers and its business partners.
And if a stock makes it beyond those two checks, then look deeper into the industry and try to model some conservative but realistic scenarios.
Fellow Seeking Alpha contributor and cannabis financial analyst Alan Brochstein of 420 Investor has covered Growlife numerous times, and published two articles on the company on Seeking Alpha. From reading his and others' research it seems that Growlife is one of the more legit cannabis stocks available (I will follow up with a valuation article on Growlife later this month). But, when the SEC halts one of the more legit names in the industry, it tells investors that they should be aware of the less legit companies.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.