The Business of Legal Marijuana: People Are Getting Rich. Should You Get In?

This article is the third of a three-part series on the business of marijuana. To read the first two articles in the series, click here and here.

The line stretched nearly around the block. To people passing by on New Year's Day, it looked like a queue for the latest iPhone release or for tickets to a Justin Timberlake concert. Few onlookers strolling down Denver's 16th Street Mall, the epicenter of the state capital's tourist industry, would have guessed they were witnessing the first state-sanctioned sales of recreational marijuana in the United States.

To say that the owner of this small but opportunistically located cannabis shop appeared overjoyed would be an understatement. He was in the zone, racing up and down the line, managing crowd control, and handing out tickets that preserved customers' spots in line -- there wouldn't have been enough room in a Whole Foods to absorb the crowd, much less in his roughly 2,500-square-foot store.

"We're on track to do $130,000 in sales today," he tells me, requesting anonymity like the other unnamed sources in this article for fear of being targeted by federal law enforcement, state regulators, or prospective burglars. On an annualized basis, that equates to three times the productivity of an Apple store, which generates more than twice the sales per square foot of the next most productive retailer. Needless to say, in an almost exclusively cash-based business, that's a lot of dough.

"The genie is out of the bottle," Roberto Lopesino of Advanced Cannabis Solutions told me earlier in the week, before legal selling began. And by the looks of it, he was right.

The promise of riches

It's difficult to describe the exuberance that pervades a new industry, particularly one that involves the cachet of a newly legalized drug like marijuana. Of the two dozen or so people I spoke with in the business, every last one of them was convinced that they were on the road to riches. Over and over again, these eager entrepreneurs made analogies to the Gold Rush of the 1860s, which originally populated much of the region, and to the growth of the Internet. "The only thing that even comes close to this," a penny stock operator with designs on the industry told me, "is the craze leading up to the dot-com bubble."

The examples of this are legion. One, a successful building contractor from Las Vegas, lost everything during the financial crisis and moved to Colorado to try his hand at growing pot. "We're not in it for the size," he tells me. "We're here to build the largest distribution network in the country," saying that it's his goal to have licenses in more states than any other cannabis cultivator. Another, a line cook at a ski resort less than five years ago, grew his operation into one of the largest dispensaries in Southern Colorado. And a third went from owning a successful janitorial company to being one of the biggest pot barons in Denver, harvesting nearly 300 pounds a month.

The exuberance stems from one thing: money. It costs the best operations no more than $800 to grow a pound of marijuana that can then be sold through their own retail stores for upwards of $3,000 a pound -- dispensaries in Colorado must grow at least 70% of what they sell. That translates into more than $7 million in profit before taxes for a 20,000-square-foot cultivation facility like the one I visited last month for research on this three-part series (for the first two articles, click here and here). At that rate, just one year's profit is more than three times the total capital expenditures needed to retrofit a property this size into the money-making machine that it is today.

It's not all gravy

This isn't to say that the money is necessarily easy. Plants, by nature, are susceptible to a variety of maladies. There are mites and molds that can ruin a cannabis crop over the course of a night. If a single light cycle is mistimed, a plant can "go hermaphrodite," meaning that it changes from female to male. It could then cross-pollinate the rest of the crop, ruining it for productive use. And if both the temperature and humidity aren't gauged precisely, the yield can be so low as to eliminate all profitability.

Moreover, simply getting into the industry can be an almost impossible hurdle. Licenses run in the tens of thousands of dollars and require the applicants to submit to laborious background checks and give up numerous constitutional rights. "They can search my personal residence without a warrant anytime they want," a grower told me. And even if you get past this initial stage, it's almost impossible to raise outside capital. Because marijuana is still illegal at the federal level, banks are prohibited from lending to operations and out-of-state investors can't put up equity for fear of running afoul of the feds.

But for those able to navigate these impediments, the world is their oyster. There are few industries that offer more protection from competition than the marijuana trade. Participants are insulated from deeper-pocketed out-of-state competitors due to the remaining federal proscription, which affects everything from banking to merchant services to taxes. Meanwhile, new in-state competitors are throttled by the same laborious licensing process and the challenge of raising capital. To top things off, many of the people who have successfully made it into the industry have little to no idea what they're doing. As one participant put it, "The industry knowledge is not deep."

A window of opportunity

How long will this opportunity last? That remains to be seen, but one thing is for certain: the countdown has begun.

"We're already seeing a commoditization in the industry," Lopesino told me. "Cannabis will ultimately be like beer. Most people most of the time drink Coors or Budweiser; only on special occasions do they drink more expensive microbrews."

In fact, according to his statistics, a full 80% of customers care about price more than quality, leading a handful of large operators to prioritize volume and thereby reduce the cost to consumers. Driving around Denver or Colorado Springs, the state's two largest metropolitan areas, it isn't uncommon to see signs advertising $99 ounces of marijuana.

It's for this reason that many industry observers are recommending that investors look to peripheral players as a source of long-term, sustainable profits. It wasn't the miners who made off like bandits during the Gold Rush, the adage goes, but rather the businesses that sold picks and shovels.

Lopesino's Advanced Cannabis Solutions provides one such example. Its business model is predicated on owning the real estate that's leased to large commercial growers at a premium of two to three times the typical market rate -- the premium reflects the legal uncertainty involved with marijuana production. ACS then supplements this with revenue from consulting services sold to prospective tenants and other, less knowledgeable industry participants.

Another example is Waste Farmers, a company founded and run by John Paul Maxfield (who also happens to be my cousin). While Waste Farmers originally started out by collecting and composting waste from commercial restaurants like Chipotle, it sold that business and used the proceeds to develop soils that can be used by, among other potential customers, indoor cannabis farmers, who now account for 70% of Waste Farmers' revenue.

"The growth of the industry has been tremendous," John Paul told me over lunch one day. "And it's not going away anytime soon."

Is this an investable field?

Whether you like it or not, the trend toward fully legalized marijuana is here and it's likely here to stay. To the enterprising investor, this begs the question: How can you get in on this potential money train? After spending upwards of a month researching the industry and speaking to both its most and least successful participants, here's what I would suggest: Leave these riches to others. By my estimation, it would take upwards of $2 million in capital to move into the market (be it in Colorado or any other state that's on the verge of legalizing marijuana for recreational use) and make it worth your while. And even then, you'd be fighting an uphill battle. In short, the first movers here have an almost insurmountable advantage.

At the end of the day, despite the magnetic attraction of a new and burgeoning industry, most investors (and particularly passive investors) would be better off sticking to more traditional investment alternatives -- namely, stocks and bonds. And there are few better places to start than The Motley Fool's top stock for 2014. If you'd like to learn the identity of this potential multi-bagger, simply click here now to download our free report revealing why our chief investment officer is so confident in this stock's future success.


Read/Post Comments (17) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 12, 2014, at 2:06 PM, 59kenb wrote:

    Hey guys, I`ve got to hand it 2 u for you 2 make it possible for meeting peoples needs, saved some people from o.d.ing on other stuff but like me I needed it real cause I`m disable and on ssi in a lot of than but I didn`t know u would run out so quick my loss,and I ran out of my pain pills not only n pain but withdraws 2, do u know where I can get some, and let me know how to get a red card thank u so much, good work. Ken

  • Report this Comment On January 12, 2014, at 4:49 PM, sellous wrote:

    I am not one who smokes and I would never encourage anyone to do so,

    But I personally believe that Marijuana should be legalized and used by professionals for health purposes under the same control as prescription drugs.

    Opening the gate for all to use it is not wise and will cause a number of health issues later on as well as road fatalities as people are using it the wrong way.

    I see first hand what ganja has done to many in the Island of Jamaica and other places all because people smoke it instead of using it the correct way.

    Having said that, I do believe the Island of Jamaica with some of the best weed should look into legalizing it, of such I am vigorously seeking investors for the cultivation of marijuana in Jamaica, as soon as the government gives us the approval to do so.

    Please go to website:

    www.silentprayerherbalcenter.com

    Thanks

  • Report this Comment On January 12, 2014, at 7:09 PM, djamesatl wrote:

    So if you've ever been convicted of cultivation, wouldn't that be an asset for getting a job at a grow company?

    Would a conviction of "sales with the intent to distribute" qualify as experience for someone seeking a job in a pot shop?

    Seems to me that this should be considered "experience" for employment.

    If so, jails in other states are full of qualified applicants!

    Do you have to pass a drug test to be employed?

    Just a thought.

  • Report this Comment On January 12, 2014, at 10:49 PM, tmorris911 wrote:

    One opportunity of the legal cannabis industry will be with the ancillary businesses that support the commercial growing operations. Still too early to tell who that will be when the dust settles. Lots of irrational excitement.

  • Report this Comment On January 14, 2014, at 1:19 AM, HawaiiJim wrote:

    Another stock to look at is Medbox (MDBX).

    They do consulting for licensing clinics and dispensaries and help state Legislators write the laws for taxation compliance. They also have computer controlled "Vending Machines" (MedBoxes) to control the sales reporting for the State Taxation Authorities. The State Tax Men love them. Very interesting Company that looks like they have done their research. Their stock is exploding.

    Their theory is: During the Gold Rush of 1849, the ones that made the most money were the sellers of shovels and picks. Medbox is selling hardware for the "Green Rush". They don't sell the plants or derivatives. They just make it easier to dispense it.

  • Report this Comment On January 14, 2014, at 12:20 PM, jwbltn wrote:

    Hey John,

    Thanks for the article. It seems to me that their is no "in" point for the average investor. Because of federal regulations it is still illegal to grow and sell marijuana. In my opinion the only people making money from this enterprise are the one taking the risk growing and selling weed. It's a bit of a "Mom and Pop" sector making Wall Street kind of money.

    Companies like Medbox aren't really tied to the money being made in this sector. Most of the "Cannibas" stocks, (AERO, MJNA, CBIS) aren't directly involved in the selling of recreational marijuana.

    Until there are federal regulations involved this type of investment is beyond the average investor.

    ps - I don't own any of the stocks mentioned above.

  • Report this Comment On January 14, 2014, at 12:22 PM, jwbltn wrote:

    My apologies for the spelling and grammatical errors in the above comment. I wish MF had a comment editor.:)

  • Report this Comment On January 14, 2014, at 12:48 PM, damilkman wrote:

    I think overlooked that each investor must decide is their personal ethics. Some refused to invest in South Africa owned companies prior to blacks being given full rights. Today some refuse to invest in alcohol, tobacco, or in industries that encourage exploitation, for example blood diamonds. Even others wish to promote what they view is a more sustainable cost model, example organic coffee grown by small farmers.

    We all have our belief systems in what we are willing to put up with. For me personally, I could never live with myself if I made a nickel on someone else's misery. For a drug that has no side effects I have to ask why so many of my pothead friends are not so happy and why others are in the grave.

    Gold has a way of making people go crazy. When I mean "gold" I am not talking about the metal but the single minded pursuit of wealth. People will make all sorts of justifications for gold, especially easy gold.

    The British traders who forced the legalization of opium in China and the Wall Street bankers who obfuscate risk with derivatives are no different then these jokers. But I guarantee you the POT sellers would tell you that a Wall Street banker is an evil unethical man.

  • Report this Comment On January 14, 2014, at 2:17 PM, bohalloran wrote:

    If you really want to make a lot of money, don't open a shop selling pot, open a shop that sells firearms.

  • Report this Comment On January 14, 2014, at 2:58 PM, hbofbyu wrote:

    No one can say smoking pot is healthy. It’s a drug. It’s dangerous, and it can be abused.

    I am trying to think how society improves with more people using drugs for recreation. Anybody have any examples?

  • Report this Comment On January 14, 2014, at 3:56 PM, Matthewuwf wrote:

    just wait till monsanto finds a way to genetically alter and patent this one...haha

  • Report this Comment On January 15, 2014, at 12:25 PM, DonaldS812 wrote:

    And the day Monsanto figures out how to genetically alter and patent a cannabis variety is the day federal prohibition becomes federal regulation and taxation. Some years ago, there were rumors, perhaps urban myths, that the cigarette manufacturers had copyrighted/trademarked product names for when the sale of marijuana was legalized.

  • Report this Comment On January 22, 2014, at 10:16 PM, Charles55 wrote:

    John,

    I enjoyed your article as it gave us a peek at the inner workings of a legal pot growing enterprise. One that most would never have access to. However, the title : "The Business of Legal Marijuana: People Are Getting Rich. Should You Get In?" implied it was possible for MF investors to get in. I was disappointed that was just a teaser and there was no real investment opportunity presented for your readers living outside Colorado.

  • Report this Comment On January 25, 2014, at 1:17 AM, SanFranPatsFan wrote:

    @hbofbyu: It is a drug, it can be abused, but it is not dangerous. There are also healthy ways of consuming it like edibles or vaporizing.

    Here are a couple of example of how legalizing it makes society better:

    Less tax dollars wasted on drug enforcement

    Less tax dollars wasted on racially incarcerating harmless individuals

    More tax dollars gained from the industry

    Less consumption of alcohol, the number one source of dependence, violence, and car accidents in this country

    Less cash flow into illegal cartel's hands

  • Report this Comment On February 26, 2014, at 4:08 PM, msverruto wrote:

    Mr. Maxfield needs to change the name or make a wholly owned subsidiary called "Wasted Farmers"

  • Report this Comment On March 15, 2014, at 12:57 PM, canv wrote:

    Not that people care, but I made well over 300k investing in CANV in a short period of time. There are small share companies like PHOT Grow life and TRTC as well that have made 300% gains and that's just the start. If you have some money to spend I would say its worth the risk. 300k isn't rich but life is easier now then it was.

  • Report this Comment On March 27, 2014, at 4:05 PM, sgshub wrote:

    I find it interesting how many are on the "why it shouldn't be legal" bandwagon, without having a full scope of knowledge on the subject. The problem is not the marijuana, just as the problem is not alcohol, from which abusers cause immense amounts of suffering (think drunk drivers just as a start).

    I believe marijuana should be legal. My guess is that most of commentators would not like to have their beer or whiskey taken away or made illegal, and the pain and suffering caused by alcohol abuse is way to significant to continually ignore.

    If marijuana were made legal, then the wasted $$ going into all forms of governmental controls could be repurposed for education, healthcare and social services. This is not that radical an idea..

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