Nasdaq-traded marijuana stocks are undervalued as investors remain skittish and as the use of drugs produced by major cannabis-focused biopharmaceutical companies have not been widely adopted.
The current options for mainstream investors in this budding sector are limited to a handful of companies listed on the Nasdaq, including GW Pharmaceuticals (GWPH , a U.K.-based biotech company with a cannabis-based epilepsy drug; Insys Therapeutics (INSY - Get Report) , a Phoenix company known for its cancer pain management drug but is developing a cannabis-based drug for the treatment of epilepsy; Cara Therapeutics (CARA - Get Report) , a Shelton, Conn.-based clinical state biopharmaceutical company that develops and commercializes pain relief drugs and Zynerba Pharmaceuticals (ZYNE , a Devon, Pa.-based company focused on developing and commercializing synthetic cannabinoid therapeutics.
While stocks like GW Pharmaceuticals and Insys Therapeutics have seen spikes in their valuations because of the positive indications from their cannabinoid-based medications for which they are seeking FDA approval, the majority of cannabinoid pharmaceutical companies remain undervalued, said Al Forman, a partner at Tuatara Capital, a private equity fund dedicated to the legal cannabis industry in New York.
"While sales of cannabinoid-based medications are starting to gain momentum, they are very much still in the early innings," he said.
Since the revenue in pharmaceutical sales revenue is directly correlated with how comfortable physicians are in prescribing certain medications as a remedy, once medical cannabis and cannabinoid-based medications become part of mainstream conversations, the valuations of these cannabinoid pharmaceuticals companies will "start moving in line with other top performers in the biopharma industry," Forman said.
As more states legalize the use of marijuana recreationally, companies such as Cara Therapeutics, Zynerba Pharmaceuticals, GW Pharmaceuticals and Insys Therapeutics will benefit, said Jason Spatafora, co-founder of Marijuanastocks.com and a well-known Miami-based stock and cannabis trader known as @WolfofWeedST on Twitter.
The legal marijuana markets generated $5.7 billion in revenue in 2015, an increase from $4.6 billion in 2014 in revenue and are estimated to reach $22 billion by 2020, according to The ArcView Group, a cannabis investment and research firm based in San Francisco.
More states are set to legalize adult or recreational use this fall. Four states have approved the use of them recreationally and 25 states passed the use of them for medical purposes. Currently, 86% of Americans live in a state that allows some level of legal marijuana use, The ArcView Group said.
"Most people don't realize that the marijuana stock market is driven by events, making this election year and a possible ruling from the DEA on removing the Schedule I of cannabis in 2016 an important time in the cyclical nature of this sector," Spatafora said. Cannabis remains a Schedule I drug like heroin; GHB, the so-called date rape drug; and Ecstasy which lack any medical purpose. Reclassifying marijuana as a Schedule II would enable scientists and doctors to study the medical benefits of cannabis, putting them on the same level and playing field of the millions drugs manufactured by major pharmaceutical companies.
"Schedule II opens the door to federal legalization," he said.
As many of these companies obtain approval from the Food and Drug Administration for the use of their drugs, the appetite for these stocks will increase. Insys Therapeutics received approval from the FDA in July for its oral solution called Syndros, a pharmaceutical cannabinoid used to treat anorexia for weight loss in patients in AIDS and for nausea and vomiting caused by chemotherapy. THC and CBD are cannabinoids, the chemical compounds generated by the flower of the cannabis plant. Pharmaceutical companies are in a race to produce synthetic versions of them since they can be approved by the FDA.
"Syndros is the second pharmaceutical cannabinoid to win approval by the FDA for marketing in the United States," Spatafora said. "Unlike Marinol, which is manufactured by AbbVie (ABBV - Get Report) as a capsule containing THC in sesame oil, Syndros is an orally administered liquid formulation that has a quicker onset and can be self-titrated, meaning the patient can use as much or as little as they need by making small adjustments in the amount they take."
The analysts for companies like INSY are bullish, and their smaller market caps make them attractive takeover candidates by Big Pharma, he said.
Many of the stocks have more upside despite having more drugs in their pipeline, and some have come off their lows after being "maliciously shorted" such as INSY, which had a 74% short interest against it, Spatafora said.
"Aside from GWPH, they all have fallen off their highs and the bears are now turning into bulls," he said.
Cara Therapeutics CARA is still relatively inexpensive, because its stock dipped by 36% in February after the FDA placed a trial for the company's postoperative pain treatment on hold.
"The company has come off of its recent lows and we see further upside from the current levels as the company continues to execute on its pipeline of products," said Michael Berger, founder of Technical420, a Sarasota, Fla.-based company which conducts research on cannabis stocks and is a former Raymond James energy analyst. "Investors might be disappointed when they report their earnings, but we could be in for a surprise."
Cannabis stocks are recession proof, because they don't have access to traditional means of capital such as major banks, he said.
Publicly-traded cannabis companies will remain "volatile, vulnerable and undervalued until marijuana is either rescheduled, preferably to Schedule II or until prohibition is repealed," said Steve Gormley, a managing partner of Seventh Point, a Norwalk, Conn.-based private equity firm in the cannabis industry.
These stocks lack support from regulatory agencies, which allows predatory lender and market shorts the ability to operate with "impunity," he said. "The SEC and other regulatory bodies don't support the growth of cannabis stocks and don't protect cannabis companies against bad actors. The regulatory environment for cannabis stocks is capricious at best and often deliberately hostile."
This intimidating environment has spurred the growth of private companies within the industry.
"Cannabis stocks just can't shake the mercurial and corrupt image that characterizes the OTC and Pink Sheets," said Gormley. "You won't see a major cannabis player on the Nasdaq until prohibition is repealed or until the drug is rescheduled."