This past summer, Vermont became the ninth state to legalize marijuana and the first to do so via state legislature. Once a taboo topic, cannabis is going mainstream. A 2018 Pew Research Poll found that 62% of Americans believe that cannabis should be legalized; this is the highest number in the last 50 years.
There is big money on the horizon here, U.S. legal sales of cannabis reached $13 billion this year and are projected to double within six years. Pile on strong medical growth prospects and you have the budding of a legitimate industry. But how can individual investors cash in on this green wave?
Access to capital is a serious issue for new companies, especially in the U.S. As long as the drug remains outlawed at the federal level, you won’t see U.S. businesses with cannabis operations listed on U.S. stock exchanges. Investors interested in these U.S. businesses must seek alternative investment structures to gain exposure. This leaves investors open to illiquid and speculative risk, two investment characteristics we find especially unappealing.
Canada on the other hand has legalized cannabis on a national scale. Companies north of the border are growing at a much faster pace since they are able to list on the Toronto stock exchange as well as U.S. exchanges like NYSE and NASDAQ, opening the floodgates for much needed capital to drive growth.
Here in the U.S., nothing quite helps stoke the flames of change like the opportunity to make some serious money. Medical marijuana sales are projected to grow by 36% per year, making it a potentially $54 billion segment by 2024. CBD, or cannabis oil, a non-psychedelic element found in cannabis, is projected to grow at 700% in the coming years! Eventually the U.S. will need to pass laws to make cannabis legal on a federal level. They will want to do this for two reasons: regulate and make money via tax revenue.
Although the hype is high and well documented, this is still an unestablished industry, so navigating the minefield may be most closely compared to the dot.com environment of the early 2000s. Back then the internet was clearly here to stay, but there were many “internet” companies that proved to be building castles in the sky, resulting in huge losses for investors wanting to get a piece of the action.
Taking up a position in any one company, especially those in new and uncertain ecosystems, is a risky proposition. The current big businesses in Canada are trading at multiples in the 100s. Most are not making money, but rather losing cash as they build up their infrastructure for potential growth ahead. This suggests that the industry is still at the beginning of what could be a hockey stick growth trajectory (see image). The next big event that will propel growth upwards could be federal legalization.
While we see strong potential for growth here, we do not have confidence in speculative industries selling at such high multiples. The same rings true for past hot ideas like 3D printing and cryptocurrency. In the current cannabis environment it is too difficult to tell which businesses will really thrive from those bound for failure. A more calculated approach may be investing in diversified marijuana ETFs to gain total sector exposure.
The four most dangerous words in the investment world are, “This time it’s different”. Cannabis could very well go mainstream like tobacco and alcohol, but remember that cannabis has NEVER been legal during any of our lifetimes and the ship may take longer to turn around than is thought. Tread carefully here and never invest more than what you are willing to lose, especially in this space.