Problems With Investing in the Marijuana Industry Today

The marijuana industry is quite large in the U.S. today, and it might be on track to grow at an exponential rate -- but the key word there is "might." Marijuana producers and dispensaries face an incredible amount of risk from multiple angles.

In this clip from Industry Focus: Healthcare, show host Kristine Harjes and contributor Todd Campbell explain the current state of the marijuana industry in this country, how much it could grow in the next few years, and why long-term investors would be wise to avoid most of the companies involved until the industry environment isn't quite so turbulent.

A full transcript follows the video.

This video was recorded on Aug. 9, 2017.

Kristine Harjes: Our first stock is not about the Gold Rush, but rather what I have heard referred to as the Green Rush, and this is the expansion of the marijuana industry.

Todd Campbell: Green gold, if you will. As you know, Kristine, I write a little bit on the subject, with some of the other Fool authors, trying to help people steer in the right direction. One of the things that invariably comes up when I'm talking to investors is the question, how big could this market really be? Everyone wants to think, what is the size of this opportunity? And the answer that I always give is big, but we don't know how big, because there's so much that's going to go into determining how much money can be made in producing and marketing and selling recreational or medical marijuana. By estimates -- and those are the only things we can use at this point -- we're talking about a market that could throw to $25 billion by 2021. And that's a huge jump from where we are today.

Harjes: Right. This is an industry that is growing at an incredible clip. Legal weed sales grew by 34% in North America to almost $7 billion in 2016. As you mentioned, they're on track to continue growing at this kind of double-digit rate. The cannabis research firm ArcView predicts that weed sales will grow at a compound annual rate of 26% through 2021, which gets you to that $22 billion in five years. I also saw that investment firm Cowen & Co (COWN) called for $50 billion in legal cannabis sales in the United States by 2026. As you mentioned, it's pretty tough to put such a precise number on this, given that there's so much regulatory uncertainty. But as of right now, 29 states have legalized medical cannabis, and residents in another eight states have said yes to having recreational weed also be legal. So, right now, you have a humongous black market in both these legal states and also all the states where it's not legal, and it's very difficult to put numbers on how much of that a legal market would eventually be able to take. But any way you slice it, this is a gigantic opportunity.

Campbell: Right. I think one of the biggest drivers of growth over the course of the next few years is going to be the passage of recreational marijuana laws last November in California, which is already the hugest market for medical marijuana, with its Emerald Triangle being one of the largest producing regions in the world of marijuana. There are already a thousand medical marijuana dispensaries operating in California, and theoretically, depending on how quickly the switch gets flipped to recreational, those could be up and running relatively quickly and providing a fairly quick ramp up for market sales. You mentioned the Cowen & Company prediction, which is just an eye-popping number, $50 billion by 2026. But, that comes with a huge caveat, and that caveat is, if recreational is legalized nationally on the federal level. Because, I think one of the things that a lot of people fail to understand is, yes, individual states are going ahead and legalizing either medical or recreational marijuana, but marijuana still remains illegal on a federal level.

Harjes: Right, and that raises some interesting challenges for the businesses that are operating in this space. Marijuana stocks have been on an absolute tear because of the hype around this industry. You hear these projections and it's hard to not get excited about, "OK, let me get in on the ground quickly, and I'm going to make millions in this." But if you actually look at the businesses themselves, they face some inherent disadvantages. For example, because marijuana is illegal at the federal level, these businesses can't take your normal corporate income tax deductions. Meanwhile, they also have pretty limited access to basic banking services like a checking account, because a lot of the financial services don't want to have this association to businesses that are technically not doing legal business at the federal level.

Campbell: Yeah. You create all sorts of risks there in the banking systems, as far as transferring money across state lines and all sorts of things. So, yes, you're talking about kind of a wild wild west rush, green rush, that we're seeing here. You have the regulatory concern. And not only is it still illegal on a federal level -- I think this is the other thing that's important for investors to recognize -- but, under President Obama, the decision was made not to get mixed up at the state level. The state said it was OK, they weren't going to enforce federally in those states. That could change under President Trump, because his attorney general is a guy named Jeff Sessions, who's been a pretty big vocal opponent to the legalization of marijuana. So, there's a lot of legislative risk and enforcement risk for these stocks. It's also still a Schedule I drug. Marijuana is still a Schedule I drug. That creates some additional risks and concerns that could limit the use of it medically, or its expansion into other states.

Then, from an individual stock-picking level, there's this whole other component of, what stock do I pick? Because most of these stocks are fly by-night companies. They're started, and their shares go out on the over-the-counter market or the pink sheets. They're very high risk companies that aren't held to the same level of scrutiny for listing requirements as, say, the larger companies that are on the New York Stock Exchange or the NASDAQ. So, if you go out and you're buying these stocks, you're theoretically exposing yourself not only to the risk of picking the wrong stock, but of picking the wrong stock and having it be a fraudulent company.