Is Now the Time to Finally Buy Pot Stocks Again?

Investing in cannabis stocks has yielded abysmal returns for investors in recent years. During the past five years, the S&P 500 has roughly doubled in value. But during that time, the value of the AdvisorShares Pure US Cannabis ETF (NYSEMKT: MSOS) has declined by a whopping 77%.

Lately, however, there's been renewed interest in cannabis. The U.S. government has been talking about potentially rescheduling the substance to a less serious level. That has many investors excited about the possibility that long-awaited reform may finally be on the horizon. Some stocks, such as Tilray Brands (NASDAQ: TLRY), have been surging in recent weeks,and it up about 27% this year.

Is this an indication that it may finally be an optimal time to invest in cannabis stocks again?

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Why cannabis reform could lead to a long-term rally

While cannabis companies are legally operating in dozens of states throughout the U.S., the substance still remains illegal at the federal level. This is crucial because it means that cannabis can't be transported across state lines, and thus, it can be expensive and inefficient for businesses to operate in multiple markets.

A company such as Tilray, which is based in Canada, can't even sell its products in the U.S. legally. It has invested in alcohol companies in the U.S. as a way to expand in the U.S. without having to be entirely dependent on cannabis. If marijuana were legalized in the U.S., that would be a huge catalyst for the business, as it would give Tilray a way to finally enter the U.S. cannabis market.

Currently, however, that still isn't on the horizon. President Donald Trump is looking at whether to potentially reschedule cannabis. Today, it's classified as a Schedule I substance with no acceptable medical use, alongside harmful drugs like LSD and heroin. But there's talk about reclassifying it to Schedule III (drugs with risks but real medical uses), which, if it happens, could pave the way for more research on cannabis.

It would also allow U.S.-based cannabis companies to lower their tax bills and increase their profits. That's because Section 280E of the tax code prevents companies from deducting business expenses when they are involved in Schedule I or Schedule II substances. Thus, rescheduling could be a huge boost for multi-state operators.

Some investors also believe that rescheduling could be an important first step to eventually legalizing marijuana.

Cannabis stocks are trading at some attractive valuations

Although cannabis stocks have been rallying in recent weeks, they are still down significantly from where they were even a few years ago. Tilray Brands is one of the more recognizable names in the industry, as it trades on a major exchange. It normally rallies when there is talk of possible reform.

Although it has been soaring recently and it hit a new 52-week high, entering trading this week, its three-year return is negative 46%. Its market cap today is about $1.8 billion, which is down significantly from the near $17 billion valuation it reached in early 2021.

The stock trades at just 1.8 times its trailing sales and at a price-to-book multiple of only 1.2. Investors are discounting it heavily, given the risk and uncertainty around the industry's growth prospects. But that could change drastically if reform opens up new opportunities for cannabis companies. However, it's unclear if reform is truly around the corner, as investors may be setting themselves up for disappointment yet again.

Should you consider putting cannabis stocks in your portfolio?

The U.S. government has discussed relaxing cannabis regulation in the past, and there have been promising bills presented that have come and gone, achieving no success along the way. And while excitement has been building around cannabis reform again, there's no guarantee or assurance that this time will be any different.

Tilray Brands and other cannabis stocks can be enticing options to hang on to for the long term, given their potential to take off if or when reform ever takes place. But that could still be years away from being a reality. That's why these types of investments may only be suitable for investors who have a high risk tolerance and who can afford to stay invested for the long haul. For the majority of investors, the safest option is to take a wait-and-see approach with cannabis stocks.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Tilray Brands. The Motley Fool has a disclosure policy.