Two questions come to mind in light of President Trump's statement a little over a week ago that he will support legislation to change U.S. marijuana laws to prevent the federal government from interfering in states that have legalized the drug.
The first question is: Will he really do it? My best guess is that he will. Trump had already committed to Sen. Cory Gardner, the Colorado Republican, in April that he'd back Gardner's efforts to permanently resolve the disconnect between federal and state laws on marijuana. His previous views also generally supported the idea of allowing states to make their own decision.
My second question is a tougher one: What's the best investing strategy if the president does support U.S. marijuana law reform and the legislation passes? One idea is to bet against prison stocks like CoreCivic (NYSE:CXW) and GEO Group (NYSE:GEO). After researching this strategy, though, my conclusion is that this is an especially bad idea. Here's why.
A good idea -- at first glance
CoreCivic and GEO Group are the two largest publicly traded private operators of prisons in the U.S. As of March 31, CoreCivic owned 44 correctional and detention facilities and operated another seven. GEO operates more than 70 U.S. correctional and detention facilities, plus others in Australia, Canada, and the United Kingdom.
The line of thinking for betting against prison stocks like CoreCivic and GEO Group consists of three components. First, the U.S. has the highest incarceration numbers in the world. Second, many individuals are imprisoned because of drug possession. Third, with more states legalizing marijuana, if the federal government gets out the way, there should be fewer prisoners. Put all this together, and it might make sense that prison stocks would suffer.
There's no disputing the first assumption. The U.S. does indeed have the highest incarceration rate of any country, with nearly 2.2 million people locked up in 2016, according to the Drug Policy Alliance.
It's also true that many of the individuals in correctional and detention facilities are there because of drug-related offenses. At least 137,000 individuals are incarcerated because of possession of drugs, according to a 2016 report released by the American Civil Liberties Union and Human Rights Watch. U.S. police arrest more people for marijuana possession than they do for all violent crimes combined.
And state support for legalizing marijuana is certainly growing. At last count, 30 states plus the District of Columbia allow medical or recreational use of marijuana. Eight of those states plus D.C. permit recreational marijuana use. Another two states could soon legalize recreational marijuana, with another state voting later in June to potentially legalize medical marijuana.
The big flaw
However, there is a huge flaw with an investing strategy of betting against prison stocks. The idea itself doesn't hold water.
Although there are many people in jail on drug possession charges, most of those crimes didn't involve marijuana. A little over 12% of individuals in federal prisons in 2012 for drug possession were there for possessing marijuana, according to a study conducted by the Urban Institute. Crack cocaine, powder cocaine, and methamphetamines were much more likely to be involved than marijuana.
Several years ago, Rolling Stone magazine reported on the top myths about marijuana. One was that prisons are full of individuals there for marijuana possession. The reality is that, while many people do get arrested for marijuana possession, relatively few go to jail. At least 22 states have rolled back laws requiring jail time for simple possession of small amounts of marijuana.
If you're looking to profit from potential changes to U.S. marijuana laws, I think there are two much better alternatives.
My view is that there's an almost surefire winner from the legislation proposed by Sen. Gardner and Sen. Elizabeth Warren, the Massachusetts Democrat, which President Trump has said he'd probably support. With projections of a $22 billion marijuana market in the U.S. by 2022 even without legislative changes, Scotts Miracle-Gro (NYSE:SMG) should benefit from growth in the industry regardless of what happens.
Back in the gold-rush days, selling shovels was the best way to consistently make money. With a "green rush" underway with growth in the marijuana market, Scotts is kind of a shovel-selling play. The company is a top supplier of hydroponic products that are important for marijuana growers.
Another investing angle is to buy one or more of the biggest Canadian marijuana stocks. Aurora Cannabis (NASDAQOTH:ACBFF), for example, is currently the No. 2 Canadian marijuana stock by market cap. Cam Battley, Aurora's chief corporate officer, recently stated that the company is "poised and ready to enter the U.S. market in a big way very fast" if federal laws are modified.
I'm not saying that Aurora Cannabis is necessarily the best pick among the Canadian companies, though. Several of the top players are likely to quickly scramble to enter the U.S. should the bill being promoted by Gardner and Warren (both from states allowing recreational marijuana use) become law.
One thing seems certain: A lot of money could be made if U.S. marijuana laws change. And based on President Trump's comments, it's more likely than ever that changes could be on the way.