This article was updated on July 7, 2017, and originally published on February, 26, 2017.
Growth in the marijuana industry has been nothing short of phenomenal over the past couple of years, and it shows little sign of slowing down. According to cannabis research firm ArcView, legal pot sales in North America increased by 34% to $6.9 billion in 2016, and based on estimates from Cowen & Co., the legal cannabis market could reach $50 billion in the U.S. by 2026.
It's not hard to understand why marijuana is performing so well, either. Since 2012, eight states have legalized adult-use recreational pot, and over the past 21 years, 28 states have legalized the use of medical cannabis. Even more important, the percentage of respondents who want to see marijuana legalized nationally, according to Gallup, has grown from 25% in 1995 to 60% in 2016.
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The momentous shift in opinion toward cannabis, as well as its rapid state-level expansion, has given investors every reason to be excited about the marijuana industry.
Not so fast! Your marijuana stock is probably a terrible investment
But the reality for most cannabis investors is that their marijuana stocks may wind up going up in smoke. Here are 10 specific reasons investing in marijuana stocks is probably a terrible idea.
1. They lack access to basic banking services
Marijuana businesses face a number of inherent disadvantages, but one of the biggest is that they have limited or no access to basic banking services, such as a checking account or line of credit. Financial institutions ultimately answer to the federal government, and providing banking services to the cannabis industry could be construed as money laundering since the drug is still illegal at the federal level. Without basic banking services, pot businesses are forced to deal in cash, which is both a security concern and a growth inhibitor.
2. They can't take normal business deductions
On top of having minimal financial services access, pot businesses are bound by U.S. tax code 280E, which denies them the right to take normal tax deductions since they're selling a federally illegal substance. The end result is that cannabis businesses are paying tax on their gross profit instead of their net profit, thus leaving less money left over to hire, buy new product, innovate, and expand.
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3. Nearly all are losing money
Another issue that investors would be wise to not overlook is that most marijuana stocks are losing money. A combination of factors that includes a lack of access to banking services, an inability to take tax deductions, and the fact that so few publicly traded companies have any long-term experience in the pot industry, means ongoing losses for many marijuana stocks.
Even the largest marijuana stock of all, GW Pharmaceuticals (GWPH), which appears to have a winner on its hands with Epidiolex, an experimental drug that helped reduce seizure frequency in two rare types of childhood-onset epilepsy, won't be profitable for years to come.
4. Nearly all are penny stocks
Just to crank up the risk a little bit more, nearly all marijuana stocks are penny stocks (defined as having a $5 share price and under) and trading on the over-the-counter exchanges. Though the OTC exchanges have done a good job with improving reporting standards in recent years, they're still nowhere near as stringent as the NYSE or Nasdaq, leaving investors to wonder if they're getting the most accurate and up-to-date financial information.
5. The industry is fragmented
Another problem for investors is that even though big business has begun to infiltrate the cannabis industry, there are still far too many small businesses. While pro-legalization enthusiasts would probably prefer to see small businesses succeed, investors usually need industry consolidation and bigger businesses to have a shot at long-term investing success. Right now, the marijuana industry is far too fragmented to be conducive to investment.
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6. The DEA says no
How can we forget that in August 2016, the U.S. Drug Enforcement Agency denied two petitions that would have rescheduled or de-scheduled marijuana from its current status as a Schedule 1 (i.e., illicit) substance? The DEA cited a lack of safety and clinical benefits-versus-risk evidence in its findings.
The bigger issue is that it can take years for petitions to make their way up to the DEA, meaning any challenge to pot's Schedule 1 status is likely to be years out.
7. There's a Congressional Catch-22
Investors are probably not going to get much help from Congress, either. Lawmakers on Capitol Hill have frequently called for more clinical benefits evidence before they'll even consider legalizing medical cannabis on a national level. But there's a problem. Without loosening restrictions around marijuana's Schedule 1 status, it becomes veritably impossible to run those needed clinical tests. This Congressional Catch-22 probably means many years to come with marijuana remaining as a Schedule 1 substance at the federal level.
8. Jeff Sessions is not a fan
The appointment of Jeff Sessions as the U.S. Attorney General wasn't good news for the marijuana industry. Even though Sessions has noted on record that he will follow President Trump's lead on pot, Sessions was one of the biggest opponents of marijuana in the Senate. Even if he maintains the hands-off approach that's currently in place, Sessions could put the kibosh on any additional state-level expansion opportunities.
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9. Expansion is more limited than advertised
Investors might also be wary of cannabis' supposed expansion opportunities. Right now there are 22 states that haven't legalized medical marijuana and 42 that haven't legalized recreational weed. However, 24 of the 50 states in the U.S. don't have initiative and referendum (I&R) laws, meaning only the legislatures of these two dozen states can pass laws pertaining to marijuana. A majority of the 22 states that haven't legalized medical cannabis lack the I&R process.
Likewise, the eight states that have legalized recreational pot may be viewed as guinea pigs for other states, meaning expansion could be limited until the already legalized states demonstrate signs of regulatory success.
10. Rescheduling may be even worse
Finally, even if Congress or the DEA have a change of heart and reschedule marijuana to Schedule 2, it doesn't necessarily make things easier for pot businesses or investors. Though it would allow the drug to be prescribed medically in all 50 states, it would also put the Food and Drug Administration firmly in control. The FDA could control the marketing and packaging of cannabis products, would almost certainly tightly oversee the manufacturing and processing of medical cannabis, and may make the industry run costly and lengthy clinical tests to demonstrate the effectiveness of marijuana in treating certain ailments. This last component is exceptionally costly and could drive some pot businesses to the sidelines.
Though legal pot sales are soaring, the deck is clearly stacked against marijuana stocks.
