The groundswell of optimism surrounding marijuana stocks may be warranted, given the latest estimates for the marijuana market in 2018. According to GreenWave Advisors, the opening up of recreational markets in California and elsewhere next year will drive retail marijuana sales to $14.5 billion, including sales taxes. Can this blossoming industry put investors on a path to riches?
Marijuana's relentless momentum
According to surveys conducted by Gallup, more Americans favor legalizing marijuana than at any other point since Gallup began asking Americans about their views in 1969. Back then, only 12% of Americans favored legalizing cannabis, but today, 64% of the country is in favor of it. Despite what we hear from marijuana foes, most Americans, regardless of political affiliation, want marijuana to move from the black market to the public market.
Image source: Getty Images.
The pro-pot movement has already led to 29 states' legalizing marijuana in one form or another. Some states have only passed laws legalizing cannabidiol (CBD), a non-psychoactive cannabinoid found in marijuana, but many states have passed more comprehensive medical marijuana laws. Additionally, Alaska, Colorado, Oregon, and Washington already operate recreational marijuana markets, and in 2016, Americans voted to establish recreational markets in California, Maine, Massachusetts, and Nevada. Those four new recreational markets will account for the majority of the increase in U.S. marijuana sales in 2018, led by California, the nation's biggest marijuana market.
The U.S. marijuana market is fragmented
Although individual states are legalizing it, marijuana's still illegal at the federal level, and that's keeping a lid on market growth.
According to Matt Karnes, GreenWave's founder, the fact that marijuana's still classified as a schedule I drug is keeping financial institutions from working with marijuana businesses, which is crimping access to capital. The inability to use traditional banking services is forcing marijuana businesses to rely heavily on cash transactions, constraining investment in production, distribution, and sales. The inability to deduct most business expenses from revenue acts as a disincentive to investment, too.
Big companies with pockets deep enough to self-fund expansion plans are avoiding the industry because of conflicting state and federal laws, as well. For instance, Canopy Growth (CGC -1.01%) is Canada's largest marijuana company, yet its management isn't pursuing a U.S. growth strategy because marijuana remains illegal on the federal level, and doing so could jeopardize its plans to win licenses in other countries, such as Germany.
Because of the challenges facing the U.S. marijuana market, small businesses that are often bootstrapped by friends and family account for a lot of the U.S. marijuana industry right now.
Image source: Getty Images.
Are there any stocks to buy?
People who want to invest in marijuana companies are probably better off focusing less on U.S. marijuana companies and more on Canadian companies or back-door marijuana stocks.
Canada has taken a national approach to legalizing marijuana. It already has a well-established and nationally regulated medical marijuana market, and it plans to make recreational marijuana available in 2018. Perhaps the two most investment-worthy Canadian marijuana stocks are Canopy Growth and Aphria, Inc. (NASDAQOTH: APHQF).
In addition to being Canada's biggest medical marijuana company, with $44 million in sales over the past 12 months, Canopy Growth is positioning itself to profit from emerging marijuana markets in Australia and Europe. It's also acquiring competitors and investing in production capacity so that it can capitalize on Canada's recreational market when it opens for business next July. The company isn't consistently profitable yet, but a potential doubling of its addressable market by the end of next year could get it there.
Aphria is smaller than Canopy Growth, but it should see its sales and net income increase because of Canada's recreational market, too. Aphria is boosting its production capacity, and it recently agreed to supply dried cannabis to Shoppers Drug Mart and Pharmaprix to better serve Canadian customers. Over the past 12 months, Aphria's sales total $16.8 million.
APHQF Revenue (TTM) data by YCharts.
If you're less interested in exposure to Canadian marijuana stocks, then another option is to consider investing in a back-door marijuana stock, such as Scotts Miracle-Gro (SMG 1.72%).
Scotts Miracle-Gro has been gobbling up companies that sell equipment and services to marijuana growers, and it expects that business will grow at a double-digit pace over the coming years. The company's Hawthorne Gardening Company brands include Gavita, Botanicare, General Hydroponics, Can-Filters, Black Magic, and others. Hawthorne's volume increased by 20% year over year, so business is undeniably booming for these products.
Points to consider
The U.S. marijuana market opportunity is huge, but it's going to require significant changes on the federal level to fully realize it. Until then, the risk of picking the wrong marijuana stock is high.
Canada's market opportunity isn't as big, but there's more clarity associated with it, and arguably, that makes it a better bet than the U.S. market. Unfortunately, investors already recognize this, so Canadian marijuana stocks aren't cheap. Shares in Canopy Growth and Aphria have soared ahead of Canada's legalizing recreational marijuana, and that could mean that investors risk steep losses if Canada's recreational market doesn't go off without a hitch.
Scotts Miracle-Gro isn't a risk-free way to play marijuana, either. The company's Hawthorne Gardening Company accounts for only a small percentage of its $2.6 billion in global sales over the past year, so even though that business is growing quickly, its impact on Scotts Miracle-Gro's top line and bottom line is limited.
Overall, there's no question that the U.S. marijuana market is going to grow next year, but there are plenty of questions associated with investing in these marijuana stocks. Therefore, buyers ought to approach this fast-growing industry with eyes wide open to the risks.
