Any investor who's familiar with Warren Buffett's investing style knows there's almost zero chance he would invest in marijuana stocks. The Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) CEO prefers low-risk investments in proven, profitable winners such as Coca-Cola or Wells Fargo, and the marijuana sector is anything but low-risk.
After last week's legalization in Canada, the marijuana industry is a financial Wild West, a wide-open space in a legal gray area with a broad range of possible outcomes. Marijuana stocks have soared in anticipation of Canadian legalization and momentum carrying over to the U.S. and elsewhere, in addition to greater acceptance for medical marijuana. As a result, some observers think there's now a marijuana bubble as companies such as Canopy Growth (NYSE:CGC), Tilray (NASDAQ:TLRY), and Aurora Cannabis (NYSE:ACB) have few sales or profits to underpin their valuations, yet they command market values in the $10 billion range.
While it's essentially certain that Buffett won't buy any cannabis stocks, an earlier statement of his gives us a clue into what his thoughts about the sector might be.
A blast from the past
During the dot-com boom, Buffett characteristically avoided tech stocks, and he's maintained a distrust of tech stocks since then, with a couple of exceptions. In 1999, during the height of the tech bubble, Buffett explained why he refrained from investing in the sector. Drawing a corollary with the early days of the automobile industry, he said there have been at least 2,000 carmakers in U.S. history, but only three survived from the early days -- Ford, General Motors, and Chrysler, now Fiat Chrysler. In a 2001 speech, he told University of Georgia students:
"And what you really should have done in 1905 or so, when you saw what was going to happen with the auto is you should have gone short horses. There were 20 million horses in 1900 and there's about 4 million horses now. So it's easy to figure out the losers, you know the loser is the horse. But the winner was the auto overall. But 2000 companies just about failed, a few merged out and so on."
In other words, though it may have been easy to spot the transformative innovation that the automobile was, betting on a winner was not. Instead, Buffett said it would have been better to short the industry that was being disrupted, which then was transportation by horse.
Similarly, during the dot-com bubble, his wisdom on tech stocks was proved right when many went belly up after the bubble burst.
How Buffett would think about the marijuana market
Though marijuana isn't exactly a transformative innovation, as it's been around for ages, the legalization of recreational marijuana could create a boom much like the advent of automobiles did. Like the early days of the car, we have seen dozens of marijuana start-ups open for business in just the past few years.
While automobiles were a clear substitute for the horse, marijuana isn't an obvious replacement for any single product or industry. However, there are two products that pot is generally seen as a substitute for -- alcohol, recreationally, and opioids, in the pharmaceutical world.
Thus far, there is some evidence that marijuana is taking away sales from alcohol and opioids. One study by researchers at the University of Connecticut and Georgia State University found that over a 10-year period, counties in states where medical marijuana is legal saw a 15% decline in alcohol sales. Other studies have also shown that marijuana is used as a substitute for alcohol, though some have found that it actually increases alcohol consumption. Certainly, there is some percentage of the population that will choose to consume marijuana and alcohol together, making the complements as well.
Earlier this year, marijuana sales topped alcohol sales for the first time in a U.S. city in Aspen, Colo., showing that marijuana's popularity is challenging alcohol's. In Canada, meanwhile, cannabis sales are expected to reach $6.5 billion by 2020, outpacing current annual sales of hard liquor at $5.1 billion.
Not everyone sees marijuana displacing alcohol, however. Constellation Brands (NYSE:STZ) CEO Rob Sands, whose company invested $4 billion in Canopy Growth, said on a recent earnings call that he saw no evidence that marijuana was cannibalizing alcohol sales.
As for opioids, many see medical marijuana as a potential savior in the opioid crisis. However, here again the data is mixed on whether marijuana decreases or increases opioid use. Some studies have found that doctors are prescribing fewer opioids and instead sending patients to marijuana dispensaries, though the issue is complicated by illegal opioids such as heroin and fentanyl.
What's an investor to do?
Though betting against horses would have been a smart move in the early 20th century, the same may not be true with shorting alcohol. For starters, the correlation between sales of the two products seems tenuous at this point, and more importantly, alcohol companies are moving fast into the marijuana industry with an eye on cannabis beverages. In addition to Constellation's tie-up with Canopy, Molson Coors has formed a joint venture with marijuana grower HEXO, and Heineken's Lagunitas brand has already launched a cannabis-based sparkling water.
Similarly, pharmaceutical companies, including opioid makers such as Cardinal Health and McKesson, generally have a broad portfolio of drugs well beyond opioids and are capable of developing cannabis-based treatments, especially as the law changes to encourage it.
Therefore, shorting opioid producers and alcohol stocks may not be the best way to respond to the marijuana boom, but investors in those sectors will nonetheless want to pay attention to the rise of marijuana and its impact on opioids and alcohol, as there is clearly a potential threat to opioid and alcohol sales.
For investors who want to heed Buffett's advice without exposing themselves directly to a stock that could go bankrupt if the bubble pops, an ETF like ETFMG Alternative Harvest ETF (NYSEMKT: MJ) may be a better way to play the boom as it allows you to spread your investment over a range of marijuana stocks.
For Buffett himself, don't expect the famously risk-averse investor to make any bets on marijuana anytime soon. At the very least, the industry would have to reach full legalization, stable profits, maturity, and also show evidence of an economic moat in order to earn Buffett's consideration.
Jeremy Bowman owns shares of General Motors. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Berkshire Hathaway (B shares), Constellation Brands, Ford, Hexo., and McKesson. The Motley Fool has a disclosure policy.