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Investing or trading shares on the open market usually requires certain principles and methodologies, yet the cannabis sector doesn’t always seem to adhere to them, especially when viewing its market activity.

Cannabis stocks have outside pressures that most industries don’t, creating uncertainty about growth, expansion and longevity. The OTC market, where most cannabis stocks trade, only adds doubt. While learning the basic investment rules is important, it helps to concentrate on practices where cannabis is particularly vulnerable.

These companies may have to deal with riskier, or at best, less desirable financing arrangements because of these outside pressures, namely banking and legalization. When most new companies are forming, they pursue financing through various traditional venues, but new disruptive and “semi-legal” ones may find it much more difficult to raise money. One of the financing arrangements they often have to resort to is offering convertible preferred shares.

These convertible preferred shares are fixed-income securities where an accredited investor can choose to earn a fixed dividend rate from the company. They can also convert those shares into multiple shares of the company’s common stock after a predetermined time span or on a specific date, hopefully when the share price has increased. The option to convert these securities into common stock gives the investor the opportunity to gain from a rise in the share price at that time.

This is calculated with a conversion ratio which represents the number of common shares to be received. The original price of the preferred shares is divided by the decided conversion rate. If the preferred convertible shares are offered at $10 per share with a conversion rate of six common shares for each preferred share, the value of each common share would be $1.67.  This number is the minimum share price for the investor to break even, or if it increases, to profit. If the share value increases to $2.50 for example, the investor can convert and earn 50%.

But converting preferred shares into common shares creates an increase in the share count and dilutes the value for common shareholders. If a company is profitable, it may buy back the preferred shares leaving the share count undiluted and preserving the share value; unfortunately, that is usually not the case in the cannabis sector.

Although owners of preferred shares may sometimes remain with the fixed dividend instead of converting, they may decide to convert if the company is not doing well; however, they also have other preferential arrangements that can have repercussions that affect the individual common shareholder buying on the open market. They will receive dividends, if any, first and before regular individual investors will. They will also be able to profit from the company if it declares bankruptcy by receiving percentages of sales of assets, something not guaranteed to the common shareholder.

It isn’t that these practices are so horrible or unethical but it means that they are hard to discover until after they happen because of the OTC status of cannabis stocks. The lack of transparency makes it difficult to discover these financial arrangements; plus, these transactions can affect the share price for companies smaller in size. These conversions appear in the charts so investors might suddenly see dramatic changes in the price, usually down, with share price reflecting the cashing in of old debt and not company performance. Growth in share count is not bad when the company is growing, but using it to pay off old debt only dilutes the value of the shares when a company isn’t growing.

This is not necessarily a bad practice should the company progress and profit, but impatience from investors or decline in value through product flaws could cause these investors to convert and this can put even more financial stress on the company. This can also create a downward spiral of share value while increasing the share count, if investors continue to convert. If the chart shows a severe drop in price within a single day or less, it would be prudent to do some research. If information is not available, it would be wise to wait until you learn more, perhaps from an SEC filing.

Learning the basics may not guarantee you will profit from a company in this sector, but understanding a company’s vulnerability will help you focus on the important details and minimize your losses.

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A recent report out by Bank of America Merrill Lynch has cannabis investors buzzing, but the real buzz may have more to do with the influence of the venerable name than the results. Does the report go beyond the surface to mine investment information that truly applies to the medical cannabis market? Having a reputable name associated with the sector certainly creates attention and eases the transition to legality, but is BofAML playing it too safe?

 

At First Look

The report raises a few questions and leaves some uncovered territory. “We think the significance of the report lies more in the fact that it is the first from a major investment firm, than in the specifics of the report which, while well researched, reflects a narrow segment of the overall medical market,” said John Kagia, Director of Industry Analytics at New Frontier Financials.

BofAML may be exploring a narrow segment, but its implications could be much larger. The data is skewed toward the pharmaceutical industries as the best bet for investment. The report seems more like an attempt to associate cannabis with the pharmaceutical industry in a sort of cultural reverse merger, a term familiar to many invested in the cannabis market. Does that limit the true potential for cannabis research? It also begs a bigger question: are bio pharmaceuticals true cannabis products?

“[The report] did not really address the potential implications of the large nutraceutical/whole-plant extract market, which will continue to a far larger proportion of the overall medical marijuana sector than just the pharmaceutical market,” Kagia said.

The stigma of illegality may have influenced BofAML’s choices for research and exploration, but a drug’s scheduling should not be a validation of its efficacy. Nor should such drugs be preferable for testing for the same reason. Creating synthetics as a way of getting around a classification may not promise the same results as authentic derivatives of cannabis.

It is unclear if BofAML is willfully ignoring the inherent conflict of interest its report poses for Bank of America Corporation and its subsidiaries. As reported by Jequetta Byrd and Laura Lieberman on Nov. 13, “When contacted by Bloomberg BNA regarding their policy on providing services to marijuana businesses, Bank of America said simply, ‘As a federally regulated financial institution, we abide by federal law and do not bank marijuana-related businesses.’”

 

Testing the Labs

There is no dispute about the need for testing standards as illustrated by ongoing problems, such as the recall by Advanced Medicine Alternatives, Denver’s 13th marijuana recall in 13 weeks.

The BofAML report names some cannabis testing labs without going into much detail; otherwise, it focuses on well-established labs, ignoring a burgeoning and important lab testing sub-sector; not only that, these labs have first hand knowledge of the plant, knowledge that can’t be trumped by chemically produced cannabinoids.

Signal Bay (OTC Pink: SGBY) and Digipath (OTCQB: DIGP) are two of the three publicly traded cannabis testing labs mentioned in BofAML’s report. CannLabs (OTCQB: CANL) gets the most attention of the three, but the company has imploded, and the founder dismissed. The economic reality of entrepreneurial investors backing the testing labs to create income can clash with the reality of trial-and error-research.

But the mainstream labs have their own issues. There is some concern about the increase in industry-funded testing. In the larger pharmaceutical sector there was a 43% increase in industry-funded clinical trials since 2006. In that same period trials funded by the National Institutes of Health have declined 24%. Pharmaceuticals, and cannabis, need consistent standards and regulation across the board, whereas individual companies usually only test their own products.

 

Synthetic Fixation

BofAML’s category of Life Science Tools, which includes consumables, is played down in contrast, but too much perhaps. Pharmaceutical testing is important but that same testing will be needed for recreational products to ensure purity and standards. The report estimates the testing market to be $800-900M and the LST sector $50M by 2020, maybe $150M at the high end.

In Colorado, medical and recreational sales were down in October due to harvest but overall consumption is up for the year. How much of that is extraction business? Nearly $700 million of medical and recreational marijuana was sold in Colorado in 2014. In only 10 months of recorded data, the 2015 numbers have already passed last year’s mark, with more than $814 million in sales. That is only one state!

Are synthetic cannabinoids the same? Is BofAML playing it too safe by only researching the data on these artificial cannabis potions? After all, synthetic cannabinoids are also sold on the street, cheaply produced with unpredictable side effects. Are synthetic cannabinoids trading off the myriad benefits of cannabis only to create adverse side effects?

The scene has changed fast since the analysts compiled their data and BofAML held its 2015 Healthcare Conference last spring. Several of the companies named have had more serious issues. This illustrates the need for accurate data about a company’s fundamentals and management and not just its progress in the labs.

GW Pharma’s (NASDAQ: GWPH) test results for Sativex were not as promising as expected. Epidiolex is still going through testing stages. The report compares it with synthetic cannabis like Marinol, also known as dronabinol, but its side effects may be byproducts of the refined synthetic material and not indicative of pure cannabis-derived medications. It also creates the misperception that natural cannabis may have those same adverse side effects. Although GW Pharma’s products may be true derivatives of cannabis, its share price has dropped from a high of $134 to $64.36, as of Dec. 22, 2015.

Perhaps synthetics were developed as a way around legalization, but do we know that they really are that effective? Judged by the current problems with Insys Therapeutics (NASDAQ: INSY), they were not efficacious, and the company has to deal with serious allegations of fraud.

Zynerba (NASDAQ: ZYNE), a company that produces patent-protected synthetic cannabinoid therapeutics for trans-dermal delivery, will not have any more study results until mid-2016, or early 2017. In the meantime, ZYNE’s share price has dropped from $43 to $11.46, as of Dec. 22, 2015.

 

Reading Tea Leaves

Although well researched, analysts may also want to spend some more time searching the fundamentals of these new and truly innovative companies and learn the tricky waters they navigate, instead of just banking on the safe ones. Big Pharma getting into the legal cannabis industry may be inevitable, but jumping the gun to create copycat synthetics and subsidizing labs to test them could create misleading and questionable data. For instance, BofAML’s report states that somnolence is a common side effect of cannabis, which is not true of cannabis in general. It depends on the strain. It is a side effect of Indica strains of cannabis, or hybrids containing it, but it is not characteristic of sativa strains. The report also seems to imply that only leaves are sold for smoking, but buds and flower are actually used from the richest part of the plant, the same as in medical use.

There is no doubt the cannabis sector is something of a minefield but maybe the real answer does lie in the actual plant, even from an investment standpoint. Are cannabis companies heading down the same road as typical drug manufacturers or are they really exploring the plant? Like many other aspects of this nascent sector, creative thinking is necessary; we can’t rely on old practices. Credible research on natural plant-derived extracts and cannabinoids should be the real foundation of this industry.

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BOULDER, Colo., Dec. 1, 2015 /Weed Wire/ — Child-resistant packaging and consistent, appropriate labeling is vital for the legal cannabis industry to move forward and it is in that spirit that CLS Holdings USA Inc. (OTCQB: CLSH), a development stage diversified cannabis company, has sponsored the inaugural white paper by MJIC Media, a marijuana media conglomerate.

The white paper, “State by State Packaging Rules Regarding Cannabis: Summary without Cynicism,” addresses specifics within cannabis packaging and labeling, including images, logos and resemblances; regulatory speed; expiration dates; and an alphabetical state-by-state review, with all the states that have legalized at least some possession or consumption of cannabis. The discussion of each state’s rules and regulations is accompanied by a link to a more official and complete source of information.

“It is important that we, as an industry, move to standardize testing and labeling across state lines,” said Jeff Binder, CEO of CLS Holdings USA. “MJIC Media is at the forefront of disseminating information to the cannabis industry. It is an honor to have been chosen by MJIC Media to sponsor their inaugural white paper.”

“We’re thrilled to produce this with CLS Holdings USA because cannabis packaging and labeling is a critical sector of the industry that all market participants need to understand and this white paper is a big step toward a broader consensus,” said Chris Gromek, COO of MJIC Media.

“The white paper should help investors and entrepreneurs by bringing to their attention the need for standardization of testing and labeling for the cannabis industry,” Binder said. “In particular, investors should consider investing in cannabis companies that perform good testing and provide good labeling for their products.”

CLS Holdings USA has made a complimentary copy of the white paper available fordownload on its website.

About CLS Holdings USA Inc.

CLS Holdings USA Inc. is a diversified cannabis company, specializing in the extraction and conversion of cannabinoids. CLS stands for “Cannabis Life Sciences,” in recognition of the Company’s patent pending proprietary method of extracting various cannabinoids from the marijuana plant and converting them into a higher quality and quantity of products. The Company’s business model includes licensing operations, processing operations, processing facilities, sale of products, brand creation and consulting services. For more information, check out: http://www.clsholdingsinc.com

About MJIC Media

MJIC Media LLC owns and operates the leading properties in the emerging legal cannabis industry, including the Marijuana Index, which tracks and reports on publicly traded cannabis-related equities; Marijuana Investor News, the premier news agency covering the industry; Marijuana Investor Summit, a premium conference provider and industry educator; and Cannabis Trader, the go-to source for cannabis investment education and stock information. For more information, visit: http://mjicmedia.com/

SOURCE: MJIC Media LLC

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For a sector that is still defining itself, finding trustworthy information to guide your investment strategy can be tricky. To know your investment it helps to know a few basics about the stock-trading world as well. The information provided here will be necessarily condensed and simplified, but it will give you starting points for your research that will help build your company files.

Information flows from companies constantly in small articles, announcements and filings so it helps to accumulate your knowledge so that it grows in an empirical fashion. Don’t invest expecting to make money overnight and don’t expect to learn how to invest overnight either. Try to find objective sources of information and not just the promos.

This sector is still evolving and has different pressures affecting it so don’t assume anything you learn won’t change, although there are certain fundamentals that underlie all sectors. Almost all of the cannabis stocks are currently traded in the over-the-counter market, known as the OTC, and are sometimes referred to as unlisted stocks. They sell through a network of dealers instead of through a central exchange like the New York Stock Exchange or Nasdaq. Since OTC stocks are geographically dispersed there is no central exchange with set rules or fee schedules that apply to all companies equally. Dealers derive their profits from the markup of their selling price over the price they paid.

A central exchange has certain financial and transparency requirements that small companies cannot meet so they trade on the OTC where it is less demanding financially and less public. They don’t have to reveal as many details about their business as required by the NYSE and Nasdaq, allowing many dubious and questionable companies to create sham businesses. Being in the OTC doesn’t automatically make companies deceitful, but it does mean the companies are often small businesses that don’t have to show you what you might need to know to invest in them. They could be foreign companies that choose to list on the OTC to avoid further expense listing on a central exchange when they already meet similar requirements in their home countries. In short, it is an area where research is essential.

Cannabis is in a unique situation of potential exponential growth both from the financial standpoint and the research and development standpoint, but has to trade in a market place with a dubious reputation. Some OTC companies are legitimate, but they may suffer from guilt by association with the OTC markets. So it helps to know the basic divisions.

When starting out investing, one of the first important words you learn is transparency, which is essentially being able to see clearly how the company functions, who manages it, how it earns money and perhaps even more important how it loses it.

You can follow the OTC stocks at otcmarkets.com, which separates stocks into different market levels based on their transparency. This categorization is more about how much information is available and does not guarantee a stock’s success or failure, or that it’s a good or bad company. However, if more information is better for keeping the perspective on a company, then you may consider this ranking as a starting point. If you belong to an online brokerage firm, it will indicate whether the stock is over-the-counter or an exchange-listed one.

The following tiers of the OTC are based on overall transparency and reporting requirements, information available, etc. It does not list all of the requirements for each tier. It’s also not a qualitative designation and the essential thing to remember is that important information can be withheld. There are exceptions, but as a rule, the lower the listing, the lower the transparency.

OTCQX is the highest tier of the three-tiered OTC markets. As defined by the OTC Markets, OTCQX “is for established investor-focused U.S. and global companies.” The SEC imposes more stringent financial and reporting requirements on the OTCQX stocks than the tiers below.

OTCQB is the second tier of the OTC markets and “is for entrepreneurial and development stage U.S. and international companies unable to qualify for OTCQX.” The OTC Markets further indicates that “companies must be current in their reporting and undergo an annual verification and management certification process.” Additionally, companies on the OTCQB must meet a minimum bid price test and cannot be in bankruptcy.

OTC Pink, with pink being a historical reference to the color of the pages that prices at this tier were quoted on, has the lowest level of reporting requirements. According to the OTC Markets, companies on this listing are “there by reasons of default, distress or design.

Beyond these three tiers, there are three additional marketplace designations that potential investors need to understand.

The OTC Bulletin Board, an interdealer quotation system, is for subscribing members of FINRA. Proprietary quotations can be entered into the OTCBB and updated in real-time. Members that submit quotes must comply with FINRA’s rules and regulations.

OTC Grey Market designates stocks that are not currently traded on OTCQX, OTCQX or OTC Pink, but broker-dealers may still be trading them without an exchange or interdealer quotation system. Because there is no centralized information on these trades, there is virtually no transparency when it comes to stocks trading the OTC Grey Market. Be wary of stocks in this category.

Caveat Emptor designates companies that have serious discrepancies and irregularities in their reporting. These could be companies on paper only or outright scams. On the OTC Markets, Caveat Emptor stocks are branded with the skull and cross bones symbol, i.e., “Buyer beware.”

Some investors will not touch any OTC stocks, others might buy only from the first two tiers. Whichever boundary you impose, you will need to continue learning about them. There is more to understand about each tier listed above because there are still some standards at the OTC level that determine which companies can move up through its tiers. They can also move down. As the companies grow and mature and demonstrate better transparency, they can also uplist to the central exchanges.

It is likely that many cannabis companies will not succeed that start on the OTC, but there will be a few success stories and this is important to understand because you may discover a company that is moving up. Usually companies that move up are progressing and growing, but not always. The OTC Markets may not seem encouraging at first glance, but they do not totally define stocks. Pioneer companies in a new sector may have to start in bad neighborhoods, but they can move out of them; as always, it helps to know the neighborhood.