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This Recent Trend Is Great for Marijuana Stocks, but Not So Great for Consumers

By Sean Williams – Jul 14, 2017 at 9:15AM

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Two recent earnings reports highlight a surprising increase in per-gram pot prices.

Marijuana stocks have been on fire for the better part of a year now, and we certainly don't need to look hard to find reasons why.

For starters, legal marijuana sales are growing at an exceptionally quick pace. A recently released report from Marijuana Business Daily titled "Marijuana Business Factbook 2017" suggests that legal pot sales could grow by 45% in 2018, and roughly 300% between 2016 and 2021 to more than $17 billion. That alone has been enough to get investors excited about the industry's long-term prospects.

A person holding the leaves of a cannabis plant in their hands.

Image source: Getty Images.

The rapidly changing opinion toward cannabis among the public is another reason why marijuana stock investors are so excited about the future. Gallup, which has been polling the public on marijuana for nearly five decades, found that 60% of those surveyed in 2016 wanted to see recreational pot legalized nationally. By comparison, only 25% of the public felt this way back in 1995. An even more recent Quinnipiac University poll this April showed that an overwhelming 94% of the public would like to see medical cannabis legalized in the United States. 

We're also seeing plenty of near-term expansion opportunities for the industry in North America. Last month, Mexican President Enrique Pena Nieto signed legislation making medical cannabis legal throughout the country. Meanwhile, Canada's parliament is currently debating legislation that would legalize recreational marijuana by as early as July 1, 2018.

And finally, a few marijuana stocks have begun to turn the corner to profitability. For instance, Canadian medical cannabis grower and retailer Aphria (NASDAQOTH: APHQF) has generated a profit in five consecutive quarters. This doesn't mean Aphria is "cheap" relative to its current P/E, but achieving recurring profitability is exceptionally difficult for most pot stocks.

This new trend is great for investors and awful for consumers

Well, there's even more good news for marijuana stock investors, at least according to the recently released fourth-quarter earnings reports from Canada's medical cannabis growers and retailers Canopy Growth Corp. (CGC -0.57%) and MedReleaf (NASDAQOTH: MEDFF).

Cannabis buds spilling out of a bottle and onto a pile of cash.

Image source: Getty Images.

As noted in both earnings reports, the average price or contribution per gram sold increased by a double-digit percentage on a year-over-year basis. For Canopy Growth, its average sales price per gram increased to 12.2% to $6.23 (8.03 Canadian dollars), while MedReleaf's full-year results pointed to an adjusted product contribution per gram sold of $6.54 (CA$8.42), an increase of 19.3% over fiscal 2016. In other words, even with production increasing in Canada, producers and retailers aren't having any problems passing along higher prices to wholesalers and consumers. That's potentially great news for the bottom lines of marijuana stocks.

Then again, it's not exactly what the consumer wants to see. The expectation is that as more producers enter the space, and more product hits the market, the price for cannabis on a per-gram basis should fall. But that's not what we're seeing. The question at this point, which we don't have the answer for yet, is whether this increase in per-gram pricing is due to a considerable increase in demand amid reduced supply, or if the concentration of supply is in too few hands, leading to significant pricing power. If I were to place my bet, I'd suggest the former is the likely culprit.

A reversal could be coming

However, we may also be on the precipice of a shift that sees pressure put on pot prices over the longer term. Health Canada recently announced changes to its medical marijuana program that'll see a number of new businesses granted licenses to produce cannabis, while newly legal recreational states in the U.S. are expected to see an influx of applications from growers. It's not uncommon to see consumer demand surge in a post-approval environment, but the initial euphoria surrounding legalization does eventually wane, which should bode well for consumers over the long run and reduce the pricing power of growers.

A person holding a puzzle piece with a giant question mark drawn on it.

Image source: Getty Images.

The big question is whether there will be enough demand to counteract weaker margins with higher sales volume. If Canada moves forward with plans to legalize recreational pot, which is estimated by the Canadian government to be a $5 billion to $7 billion a year opportunity, the answer is probably "yes" for Canadian producers like Canopy Growth, Aphria, and MedReleaf. But, if Prime Minister Justin Trudeau's aspirations to legalize recreational cannabis once again fizzle out, we could see weaker margins and slower profit growth ensue, because there's only so much cost-cutting and efficiency these companies can squeeze out of their operations.

There's no denying that legal marijuana is an intriguing investment opportunity given its exceptionally high industry growth rates. But there are also some clear-cut concerns that this growth and investors' lofty expectations may not translate into big profits for marijuana stocks. Until we have an idea of what'll happen in Canada with its recreational pot bill, your smartest bet is to remain on the sidelines and allow the marijuana industry time to mature.

Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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