With the exception of bitcoin, there probably isn’t an investment topic that’s been covered more extensively in recent years than marijuana stocks. It’s not hard to see why, either. Since the beginning of 2016, quite a few of the largest pot stocks by market cap have gained in excess of 1,000%. By comparison, stocks have historically gained about 7% annually, inclusive of dividend reinvestment and when adjusted for inflation. In short, marijuana stocks are leaving their publicly traded peers in the dust.
However, investing in marijuana isn’t as simple as it sounds. There are a lot of things that current and prospective investors need to be aware of if they hope to turn a profit. Below, you’ll find a list of 20 things you should know prior to putting your money to work in the cannabis space.
1. The public supports legalizing adult-use weed
To begin with, the American public is very much in support of seeing cannabis legalized. Five separate polls over the trailing year from the likes of Gallup, Fox News, CBS News, Pew Research Center, and the independent Quinnipiac University, have found support for legalization among adults ranging from 59% to 64%. By comparison, just 25% of respondents approved of legalization back in Gallup’s survey in 1995. This shows just how quickly the perception of cannabis has changed in a shade over two decades’ time.
2. And it overwhelmingly is in favor of legalizing medical cannabis
Support for legalizing access to medical cannabis is even higher. A late April 2018 survey from Quinnipiac University found that 93% of those surveyed supported the idea of patients having access to medical weed prescribed by a physician. That compared to just 5% who opposed the idea.
3. Marijuana is illegal in all but one country
Nevertheless, marijuana remains wholly illegal at the federal level in the United States. As a Schedule I drug it’s illegal, considered to be highly prone to abuse, and has no recognized medical benefits. Of course, the U.S. is far from alone. Aside from Uruguay, cannabis is illegal in every other country around the world, albeit more than two dozen countries have implemented broad medical cannabis use laws, including Canada and Mexico.
4. 29 U.S. states have broad-sweeping medical cannabis laws
Within the U.S., a sort of bifurcated system exists that’s thus far allowed states the ability to legalize and regulate recreational and/or medical marijuana independently of the federal government. Since 1996, when California became the first state to legalize medical marijuana for compassionate-use patients, 29 states in total have passed broad-sweeping medical pot laws.
5. Nine states allow adults to use recreational cannabis
Additionally, nine states have OK’d the use of recreational marijuana since the November 2012 election. The latest to do so is Vermont, which gave the green-light to recreational weed entirely through the legislative process in January — i.e., without residents having to vote on the issue. Residents in the other eight states approved their cannabis initiative by voting it into state law.
6. Financing is a challenge
Because marijuana is illegal at the federal level (and in practically every country), gaining access to basic banking services, including lines of credit and loans, can be a genuine challenge. Financial institutions fear the possibility of monetary fines and/or criminal charges for aiding cannabis-based businesses, which means most banks tend to avoid the industry altogether.
7. Shareholder dilution is common
So, how do marijuana stocks get access to capital? In the U.S., it’s often through common stock offerings, while in Canada it’s through bought-deal offerings. A bought-deal offering involves the sale of common stock, convertible debentures, stock options, and/or warrants to an investor or group of investors in order to raise capital. Either way, both methods increase the outstanding share count for a publicly traded company, diluting the value of each existing share of stock. Dilution is one of the more serious concerns pot stock investors face.
8. U.S.-based cannabis businesses pay exorbitant tax rates
On top of facing financing struggles, marijuana businesses in the U.S. that turn a profit could face one heck of a surprise. A more than three-decade-old tax code (Section 280E) disallows businesses that sell a federally illegal substance from taking normal corporate income-tax deductions. Without the ability to take these deductions, weed-based business can face an effective tax rate of as much as 90%.
9. Just one approved federal grow facility in the U.S.
Patients who could benefit from medical marijuana also potentially get the short end of the stick. There’s currently just one approved federal grow facility in the U.S. — the University of Mississippi — meaning supply for researchers to use in clinical testing is somewhat constrained. Furthermore, there’s a lot of regulatory red tape to deal with prior to running clinical benefit-versus-risk studies.
10. The FDA may be on the verge of its first cannabinoid-based drug approval
Interestingly enough, though, the Food and Drug Administration (FDA) appears to be less than two months away from giving the thumbs up to the very first drug derived from compounds found in the cannabis plant (known as cannabinoids). GW Pharmaceuticals’ Epidiolex, which is designed to treat two rare forms of childhood-onset epilepsy, easily met its primary endpoint of a statistically significant reduction in seizure frequency, relative to baseline and when compared to the placebo, in multiple late-stage studies. GW Pharmaceuticals’ lead drug was also unanimously recommended for approval by the FDA’s advisory panel in April. History could be around the corner, with an FDA decision date currently set for June 27.
11. Trump backs states’ rights
Where does President Trump stand on all of this? Recently, he’s stood behind the right of states to choose whether to legalize cannabis. But Trump hasn’t always been this forthcoming about his support for legal marijuana. He also shut down Israel’s attempt to export medical weed to the U.S. earlier this year. Such a move seems odd for a president who’s suggesting he supports states’ rights.
12. Jeff Sessions is the industry’s primary enemy
On the other hand, it’s plain as day that Attorney General Jeff Sessions is enemy No. 1 of the marijuana industry. Having suggested that “good people don’t smoke marijuana,” Sessions has tried on numerous occasions to slow, halt, or reverse the state-level expansion of the legal weed industry. His only success thus far has been in rescinding the Cole memo on Jan. 4, 2018.
The Cole memo offered a set of loose guidelines that legalized states would follow to keep the federal government off of their backs, such as keeping cannabis grown in a state from leaving its borders. The rescinding of this memo opens the door for state-level prosecutors to use their discretion when bringing charges against businesses or individuals who violate the Controlled Substances Act as related to marijuana.
13. Canada is on the verge of recreational legalization
Though the U.S. could very well the most lucrative marijuana market on the planet, if legalized, that title goes to Canada. Our neighbor to the north appears to be just weeks away from legalizing recreational marijuana for adults, and in the process becoming the first developed country in the world to have done so. The groundwork has been laid for the Cannabis Act to pass — now it’s just a matter of waiting for the June 7 Senate vote.
14. Very few countries are authorized to export cannabis
Of course, Canadian growers are counting on demand for pot to extend well beyond Canada’s borders. Canada, along with the Netherlands, are one of just two countries that actively export cannabis to countries that’ve legalized medical marijuana. However, Australia is expected to enter the cannabis export arena soon enough.
15. Canopy Growth Corp. is the industry’s biggest player
The kingpin of all marijuana stocks for the time being is Canada’s Canopy Growth Corp. Last month, Canopy announced that, with recent licensing approvals from Health Canada, it had 2.4 million square feet of licensed grow space. That’s three times higher than where it began the year. Ultimately, Canopy Growth expects to have 5.7 million square feet for production, which may yield upwards of 500,000 kilograms of dried cannabis a year, by my best guess.
16. Oversupply is a genuine concern
With Canada expected to legalize recreational weed by this summer, the race to produce as much marijuana as possible is on in Canada. Unfortunately, it may also lead to a glut of supply. Though estimates vary wildly, annual domestic demand in Canada may only total 800,000 kilograms. Yet, fully funded production from the dozens of licensed producers looks to easily top 2 million kilograms by 2020 or 2021. Where does this greater than 1 million kilogram oversupply go? Exports are the wildcard here. If foreign countries gobble up all of this excess supply, margins won’t take a hit. If not, oversupply could cause legal weed prices to plunge.
17. Most pot stocks trade on the OTC exchange
Investors should also be aware that most marijuana stocks are listed on the over-the-counter (OTC) exchange. Thankfully, reporting standards have improved dramatically in recent years on the OTC exchange. However, liquidity can still be a challenge, especially since institutional investors usually avoid investing in stocks that aren’t listed on reputable exchanges.
18. Profitability is minimal, in most cases
Even though the marijuana industry has investors seeing green, cannabis businesses themselves may not be anywhere near as profitable as you might think. Capacity expansion and reinvestment is sucking up a lot of operating cash flow for the time being. Meanwhile, rapidly rising outstanding share counts as a result of dilution tend to push EPS lower, making a stock appear pricier on a fundamental basis. Long story short, this industry doesn’t offer much in the way of value as we traditionally think of it.
19. Oils and extracts are a higher-margin product
Product differentiation is important for marijuana stocks, and moving beyond highly commoditized dried cannabis products is critical to success. In particular, companies that retail cannabis oils and extracts stand to generate juicier margins than those that don’t. Oils and extracts have a significantly higher price point and target niche consumers. They’re what I’d call the secret sauce to increasing margins.
20. The ancillary business could be even more exciting
Last but not least, don’t ignore the ancillary marijuana businesses. In other words, don’t forget about the companies behind the scenes that aren’t coming in contact with the cannabis plant. Companies like Kush Bottles that specialize in child-resistant and tamperproof packaging may play just as important a role as the growers themselves.
Now that you’re armed with the knowledge you need, it’s time to ask yourself: Are cannabis stocks a fit for my portfolio?