Marijuana Stocks: What Could Go Wrong?

Marijuana legalization is creating a green rush among investors, but there are risks to consider.

Motley Fool Staff
Motley Fool Staff
Oct 14, 2018 at 5:45PM
Health Care

If you're tempted to buy marijuana stocks, you're not alone. The marijuana market is valued at more than $150 billion annually, and momentum to legalize it in the U.S., the world's biggest market, is building.

Nevertheless, caution is warranted. Governments could balk at pro-pot initiatives, demand could wane if taxes are too high, valuations are arguably pricing in a lot of the opportunity, and there could be unforeseen negative consequences associated with widespread marijuana use. In this clip from The Motley Fool's Industry Focus: Healthcare, analyst Shannon Jones asks guests Todd Campbell, Sean Williams, and Keith Speights what it is about this market that keeps them awake at night.

A full transcript follows the video.

This video was recorded on Oct. 10, 2018.

Shannon Jones: We've talked about the huge growth opportunities, how the market is so tremendous for the marijuana industry. With that, this is still an industry that has many challenges to go. You alluded to that just now. If there was one thing that kept you up at night when it comes to investing in this space, what is that?

Sean Williams: I'll kick us off again. It would be that marijuana is seen as the next big thing right now, and every single next big thing that we've seen over the last 25 years has ended in a bubble bursting. We saw it with the internet, internet business-to-business commerce, genomics, 3D printing, cryptocurrency/blockchain. And I believe we're seeing it with marijuana now. There's that worry that history will repeat itself.

There's also the worry that even though we haven't seen a lot of precedents of countries legalizing recreational marijuana, we can look south of the border into the U.S. from Canada, and we can see some of that precedents in Colorado, Washington, Oregon. In all three of those states, after a short period of euphoria and demand and consumers just jubilant and ready to buy marijuana, the price per gram of that dried flower -- which is mostly what we're going to see in the early going, until Parliament in Canada decides to do something about it -- there's a good chance that the price per gram is going to drop.

The good thing for these marijuana companies is that scale will help them reduce their cost. But there is nothing built into that scale that's going to prevent the price from dropping 20%-40%. It will hurt. There's a very real chance that these companies, between their high initial spending, and if the price of cannabis starts dropping, they may not make anywhere near as much profit as anyone expects.

I believe that's the biggest worry, somewhere between history and the price per gram of cannabis falling.

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Todd Campbell: Right. You can have a disruption in an industry, and it can be a real disruption, it can be a real market-moving event. That doesn't necessarily mean that you're going to have runaway stock prices forever.

Williams: Correct.

Keith Speights: I would second that. Valuation. The valuations are absolutely ridiculous, especially with some of the more well-known Canadian stocks.

Williams: [coughs] Tilray.

Speights: Yeah, Tilray. These stocks have gotten disconnected from the legitimate business prospects. Now, don't get me wrong. Tilray has legitimate business prospects. Their sales are going to grow phenomenally. There's no doubt. But their stock more than reflects those growth prospects, way more than reflects them. If I had bought Tilray, I would be running like the wind right now. But it's not just Tilray. A lot of the stocks are overvalued. Yeah, we're seeing a bubble, for sure. But, again, it's a legitimate industry. Over the long run, there are going to be some big winners.

Campbell: Yeah. You guys both made great points, it made me think of something. One of the things that I'm a little bit worried about is that, we are talking about how exciting medicinal marijuana could be. And in that excitement, maybe we're forgetting that, along the way, we've already had GW Pharmaceuticals. They've already had readouts from trials in indications that we thought would be home run indications, and easily done. And those trials have failed. Pain being the best one that jumps to mind. They ran a bunch of pain cancer trials, and those failed to beat the placebo. That was a disappointing setback. So, ratcheting back some of the enthusiasm that you're hearing on today's show is Todd Campbell. I'm just saying, OK, yeah, there's going to be fits and starts along the way.

The other thing that keeps me up at night is the potential risks of the unknown, the unintended consequence of this surge in marijuana use. When we were talking about edibles, I'm not necessarily as concerned. But there's a part of me, and I don't know if it's because I grew up in the '80s or not... hmm, Reagan times... there's a part of me that says, if you're smoking some smoke, into your lungs, maybe there's an unintended health consequence that evolves later on. And studies that have been done so far have not been able to draw a concrete link. That's because a lot of people who smoke marijuana also smoke cigarettes, so they've not been able to separate the two and figure out what's doing what. Now, marijuana does show some anti-cancer properties. So there's some argument there that maybe we won't see those kinds of things.

Again, we're just speculating things that could keep you up at night. One of those things that keeps me up at night is, is there an unforeseen or unknown consequence that we just don't fully understand yet?

Jones: Yeah. I think all of those points are so valid. If you had a brand-new investor to this space, just to close us out, what would be the one thing you would want them to take away from this conversation?

Speights: I would say, remember we're still talking about businesses. Don't focus on the stock, focus on the business. Just as you wouldn't spend $1 million to go buy a neighbor's lemonade stand, look at the realistic business prospects, and make sure that you're paying a price that, over the long run, you'll get a good return.

Jones: Excellent!

Williams: I would emphasize, and build on Keith's point, businesses take time to mature. Whereas we've seen all those other businesses I described -- the internet. There are plenty of successful internet companies. There could be an Amazon of this group. But it's going to take time. It's not just going to launch out of the gate and be off to the races and that's that. If the market worked like that, I think we'd all be retired by now. [laughs]

Campbell: Sean, you don't mean that every single one of these is going to be the next Amazon?

Williams: [laughs] Wouldn't that be great?

Campbell: Will some of these fail?

Williams: I think so!

Campbell: Yeah. I think that's definitely a great point. That's why -- Shannon, guess what I'm going to say! -- diversify!

Jones: [laughs] How did I know that, Todd?

Campbell: I might say that every once in a while on the show. You're probably sick of me saying it. But, yeah, diversify! Create a little basket, if you're really interested and you want to be involved marijuana stocks, to have some in your portfolio. We talked in the past, when you talk about truly disruptive things, it doesn't move in a straight line. You may lose a lot of money in certain periods of time. But if you believe that the $150 billion market is being disrupted by legalization globally, and that some of these companies that are at the forefront right now are going to be around in 15-20 years to benefit from it, then diversify. Own a few.