This article was updated on June 5, 2017, and originally published on Jan. 22, 2017.
In November 2016, Californians overwhelmingly voted to embrace pro-pot laws that clear the way toward creating the United States' biggest recreational marijuana market. Is California's marijuana market a boon to marijuana investors? Read on to see how big California's marijuana market could become.
First, some history
California pioneered medical marijuana legalization in the 1990s, but it has been slower to endorse laws that open up the recreational marijuana market.
In 2010, California's Proposition 19 fell on deaf ears when 53.5% of voters opted against passing it. If it had been passed, Proposition 19 would've allowed Californian adults over age 21 to possess up to 1 ounce of marijuana for personal consumption and to grow marijuana in a space of up to 25 square feet.
At the time, supporters applauded Proposition 19 for its potential to help end the drug war with Mexico while generating significant tax revenue. At least one report suggested that if passed, Proposition 19 could've saved $200 million on law enforcement expenses and added $1.2 billion annually in tax revenue.
However, the opposition convinced the majority of voters that those savings and tax receipts were overstated, and as a result, the bill failed to pass.
A pro-pot victory
Opinions on recreational marijuana have changed significantly since Proposition 19's failure in 2010. Colorado and Washington passed recreational marijuana laws in 2012, and Oregon and Alaska joined them in 2014. So far, legalization in those states has been a success, particularly in terms of increasing tax revenue, and that's helped improve perceptions of recreational marijuana.
In Colorado, marijuana sales eclipsed $1 billion in 2016, up 30% from 2015, and as a result, the state collected $200 million in marijuana taxes, fees, and licenses last year.
Thanks to states like Colorado trail-blazing recreational marijuana, national support for legalization has grown, and pro-pot advocates faced a less rocky road to victory last November.
In California, the Adult Use of Marijuana Act, or Proposition 64, passed by a vote of 57.13% for and 42.87% against, and that means that Californians can now possess up to 28.5 grams of marijuana and grow up to six plants.
The law sets up a process for licensing dispensaries that can sell marijuana and marijuana products, and it gives California the right to charge fees and collect taxes on marijuana.
It will take some time to get California's recreational market fully up and running, but California's got well-established medical marijuana production and distribution infrastructure in place, and that should help matters. For instance, California's Emerald Triangle region is already considered the largest area for cannabis production in the United States, and more than 900 medical marijuana dispensaries already operate in the state.
California's marijuana infrastructure has Matt Karnes, founder of GreenWave Advisors, LLC, estimating that the state's marijuana market could grow from about $2.8 billion per year in 2017 to $5.8 billion per year in 2018. Karnes predicts California's recreational marijuana market could reach $7.7 billion as soon as 2021.
Investing in marijuana stocks
A more than doubling in California's marijuana sales over the next five years has many investors hunting for stocks that could benefit from it.
Unfortunately, the marijuana market remains dominated by small players with limited market share, and as a result, most publicly traded marijuana stocks trade on unregulated over-the-counter markets that are ripe for fraud. Additionally, because these companies are reinvesting heavily into their businesses to benefit from growth, many of them are unprofitable.
Marijuana investors also have to be careful because the industry faces risks associated with uncertainty at the federal level. Nationally, marijuana remains illegal, and the appointment of legalization foe Jeff Sessions as U.S. attorney general does little to assuage fears of a federal crackdown on growers and dispensaries.
Because of the risks, Americans interested in investing in marijuana stocks are left with few choices. They can invest in Canadian marijuana stocks that also trade on the U.S. stock exchanges, or they can invest in drug companies attempting to develop treatments that are derived from cannabis' chemical cannabinoids.
Two Canadian companies that are worth considering are Canopy Growth Corp (TSX:WEED) (NASDAQOTH:TWMJF) and Aphria, Inc. (NASDAQOTH:APHQF) However, both of these companies are investing heavily back into their businesses, and thus, could have uneven profit growth over the coming years. Shares in these two companies are also being richly valued by investors already.
For instance, Canopy Growth is a leader in Canada's medical marijuana market, and it has inked a marketing deal with marijuana icon Snoop Dog that could help accelerate sales. However, revenue is less than $10 million per quarter, yet its market cap is nearly $1 billion.
Similarly, Aphria's knee-deep in expanding its marijuana production, but it only earned CAD$0.04 per share last quarter on just CAD$5.1 million in sales. Yet, it's being valued at roughly a half billion dollars.
Shifting gears, GW Pharmaceuticals (NASDAQ:GWPH) and Insys Therapeutics (NASDAQ:INSY) are two of the most investment-worthy marijuana drugmakers, but only GW Pharmaceuticals shares may make sense to buy right now.
Last year, results from three trials of GW Pharmaceuticals' purified cannabidiol (CBD), Epidiolex, showed it can reduce monthly seizures in patients with tough-to-treat forms of epilepsy by about 40%. Following those results, GW Pharmaceuticals plans to file Epidiolex for FDA approval this year. If the FDA approves it, Epidiolex could become a nine-figure top-seller someday.
Insys Therapeutics' story is less compelling. While Insys won FDA approval to market a new formulation of the long-standing THC drug Marinol in 2016, it has yet to receive DEA scheduling for the drug. Furthermore, Insys Therapeutics' management is embroiled in a long investigation of potentially illegal sales and marketing practices for its opioid spray, Subsys. Until those investigations wrap up, Insys Therapeutics is a high-risk stock to buy.
Overall, California's approval of recreational marijuana should provide significant new opportunities for marijuana companies, but this market is in the very early innings, and that makes investing in it quite risky.
Todd Campbell has no position in any stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.