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Marijuana Stocks: What Exactly Are You Buying?

|Includes: Cannabis Science, Inc. (CBIS)

There has been a lot of talk lately about whether analysts are "bearish" or "bullish" on this industry. I think these views are cop-outs. It is more complicated than that.

To start, there is money being made and to be made. The questions you should ask is how much and when? An estimated $1.34 billion was made in marijuana sales in 2013 and some have projected that number to nearly double in 2014. So money is being made. But can you make some too?

But SEC rules forbid public companies from dealing in federally illicit commodities. So when you are investing in pot stocks, you are not touching that green. Furthermore, from an equity standpoint, 2 billion is considered small-cap. Considering that the term 'small-cap' is designated for individual companies and not an entire industry, we are more likely looking at nano-cap companies. But current valuations of pot stocks are individually moving into small-cap zones without ever posting a profit.

For eager investors hoping to cash in on this burgeoning industry, pot stocks have become an enticing way to get in on the ground floor. The idea being that Cannabis Science Inc, (OTCPK:CBIS), Medical Marijuana Inc, (OTCPK:MJNA), or even Growlife Inc, (OTCQB:PHOT), might be that opportunity. And for many it has. Money made.

But an essential question that has not been asked is why did these companies go public so early in the game? The obvious answer is that they needed cash. But before just giving anyone your hard earned cash, you should investigate why they need it; whether they will use it effectively and efficiently; and finally, whether they will be able to give a sufficient enough return to justify your injection of capital.

A lot of these companies have been publicly traded for a while now. CBIS has been incorporated since 1998. Researching CBIS' historical profitability and management of capital can give you an idea whether you should trust them with your cash.

CBIS is one of my favorite pot stocks because it epitomizes the fundamental flaws in this industry. Before discussing valuations, business model, and speculative growth, have you checked it's SEC disclosures? CEO and President Robert Melamede, the eponymous medical marijuana guru, has been disposing his stake in CBIS on a daily basis since January 2, 2014. Although insider trading is not the only criteria investors should look at, it does give potential investors an idea how management evaluates the future of the company.

As of March 31, 2013, Dr. Melamede owned 50340333 shares of out of its 684,390,573 shares of common stock (currently there are 761,323,906 shares outstanding). In the last month and a half Dr. Melamede has disposed of 5 million of his 50 million shares, roughly 10% of his stake. For a company that has yet produce a sellable product, it seems quite suspicions that Dr. Melamede should be dumping this early. Who knows, those shares could be worth 10x that amount once they finally have synthesized there cannibanoid-based formula (CBDs) for treating cancer, ADHD, and HIV. Seriously. If CBIS has in fact discovered a way to synthesize CBD to cure cancer, then this company has yet to see its true value.

So why is Dr. Melamede selling? Because you are buying. Maybe Dr. Melamede's wallet is a bit light and needs the extra cash. But remember, that is your cash, your investment dollars. And finding the cure for cancer is expensive. CBIS has already racked up 90 million in debt. Yet its current market cap is 140 million. That amount is not based on earnings, not based on equity, and not based on tangible assets. Those are investment dollars that have been poured in since Colorado legalized marijuana.

A look at CBIS historical disclosures give us an insight as to what your investment dollars have bought you.

In 2000, CBIS went public as National Healthcare Technology Inc. Dr. Melamede was not part of the roster at this point. The company had a total of $18,334 in assets and somehow already managed to rack up 1.2 million in debt. Of course publicly traded pharmaceutical companies tend to hold a significant larger amount of debt than other companies. That is due to the high costs of development.

In their 10-SQB disclosure, the company explains that they decided to go public so as to fund their Phase III trial of their intravenous drug Magkelate. However, without enough cash and their developer supposedly dying, the company lost its patent and became inert for several years.

For the next few years, the company decides to leave the healthcare industry and try its hand at "manufacturing and distributing decorative stone veneers and finishes." Any sudden change in business direction should give investors caution. But the company does not go into massive debt at this point. This remains the case through September 2005 when National Healthcare Technology's accumulated deficit still amounted to only 700k. But in 2006, the company began acquiring massive amount of debt. Why?

In 2006, National Healthcare Technology decided to make another direction shift. Now, National Healthcare Technology is in the oil and gas business. They acquire an initial 11 million debt to fund this new direction. By June 2006, this number spikes to 26 million, 15 million of which are for "professional fees." These fees are for a Ross-Lyndon James, the then acting President, Director and CEO, as well as Brian Harcourt, which from their disclosure appears to be Mr. James' lackey.

Skipping the part where the company changes its name to Gulf Shore Inc, we come now to 2009 when National Healthcare Technology makes another shift in business model: Cannabis Science. As of April 6, 2009, the company decides that it is going back to the healthcare business with a going concern of cannabis pharmaceutics.

Even though the company changed its name, it still has retained its accumulated deficits amounting to $52 million without having made a return on their investment. This deficit has not gotten any lower. CBIS' most recent quarterly reports show that this figure has grown to 90 million. In addition, CBIS has disclosed they also have nearly a 3 million stockholder deficit.

Now, consider again why Dr. Melamede is selling. And according to its latest filing, CBIS needs more cash if they are too sustain business operations.

If CBIS fails to produce its CBD-based drug like Maklegate, it will just change its business model to whatever the next big trend is. Yes this company needs cash. It needs cash to fatten the wallets of the company's management who have failed to provide their investors will a solid return.

CBIS is just one of the many pot stocks trading now with unrealistic valuations. Behind every Pot Stock ticker there is a story of a company that has changed business directions and has failed to use capital effectively. True, certain companies trading now may be the future of this industry. But as of now, the money is in the idea not the business.

If you owned pot stocks prior to January 1st, you most likely have doubled or even tripled your position. That is great! But how long will the hype last? How long until investors look behind the glossy websites and the slick pitches and see that the game is rigged against the investor.

For those investors now trying to get in now after eyeballing 300%-3500% spikes in the last month, who do you think will buy your investment? And now that you own stake in CBIS, RFMK, or ENDO what exactly do you own? Do you really know?

Money is being made. It is being made on the idea of pot stocks becoming main stream investment opportunities. However, little analysis is being done on how legalization will actually affect the future value of a marijuana as a commodity. Sure, as an illicit drug, or even as a deregulated drug, an ounce can still go for $600. But the price for this commodity will surely go down as it becomes easier to grow and sell.

You probably think I'm bear. I'm not. I think money can still be made as long as you understand how the game is being played. In fact, a lot of money will be made as this continues to be a volatile industry. What these past two months show us is that investors like the idea of investing in pot. And sometimes that is all it takes for you to make money. And if you understand that what you are buying isn't a share in the next market revolution but a fleeting idea, you can play this industry to your advantage.

First: news is key. Doesn't matter if it is positive, negative, or neutral, much of what drives these stock prices up is that they are being recognized as a pot stock. The smart marijuana investors understand that no company has sufficiently demonstrated a long play. They are betting that they can make a quick return on their investment by investing in a pot-stock first.

Which brings me to my second point: watch out for companies that change their "going concern" to marijuana. Remember you are not actually buying a piece of the company's equity or future earnings but the idea.

Finally: don't hold on forever. Look at how other investors are valuating the marijuana industry. You can always buy back in if you want but you will never get back those quick gains.

Now, does this sound like solid investing ideas? Of course not. But this is how it is being played. The volatility and the market caps tell the story. The people investing in this industry are not billionaire hedge-fund managers who can single-handedly control the price of a security. They are intrepid investors like you willing to stake a few thousands they have saved up in hopes of doubling or tripling their money quick. And if you want to make money, you have to play this industry as well. Otherwise, you might be the last one holding shares in a company with zero assets and a debt of 90 million.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.