Last year was historic for cannabis. Canada became the first industrialized country to legalize marijuana, and California's recreational sales started.
Then, 2019 began on an exciting note. On Jan. 1, it became legal in the U.S. to produce hemp and products derived from marijuana's cannabis cousin, thanks to the passing of the U.S. Farm Bill in 2018. Companies are already eagerly entering this space, and investors can expect more to follow. There's probably room for multiple winners.
Here are eight reasons that investors with higher risk tolerances should consider investing in a company involved in the marijuana or hemp fields.
1. The cannabis sector is performing powerfully
It's never a good idea to buy a stock based on past performance, as it's not a guarantee of future performance. But when certain stocks begin to take off ahead of the market, it's often because strong, long-term growth in the sector or industry is being projected by the experts. This is the case with cannabis stocks.
Investors need to be careful, though. Most companies in the cannabis realm will probably be losers, falling by the wayside as the newly emerging and fast-evolving space consolidates and matures. However, there will almost certainly be long-term winners among the early entrants.
Cannabis stocks have largely raced out of the gate in 2019. Shown below are the stock performances of the five largest marijuana growers by market cap -- Canopy Growth (CGC -7.01%), Aurora Cannabis, Tilray, Cronos Group (CRON -3.49%), and Aphria -- and that of a notable ancillary cannabis player, Innovative Industrial Properties (IIPR -1.55%). All five growers are based in Canada, the epicenter of the global cannabis market due to being the first industrialized country to legalize marijuana. San Diego-based Innovative Industrial is a real estate investment trust (REIT) focused on the marijuana sector.
These stocks are the large players in their respective niches of the cannabis sector. Below is the one-year picture, excluding Tilray which isn't included because it's only traded on a U.S. exchange since July.
2. Torrid growth is expected in the global marijuana market
The budding legal marijuana market is widely predicted to grow like wildfire worldwide. Arcview Market Research and BDS Analytics expect the market to grow from $9.5 billion in 2017 to $32 billion in 2022 -- 27.5% compound annual growth rate (CAGR).
3. Momentum toward U.S. legalization could boost marijuana-market growth projections
Growth projections for the next five years, and sometimes longer, generally don't include the potential for a huge boost that will happen if the U.S. legalizes marijuana on a federal level. So, if this event occurs sooner, rather than later, current growth projections should prove too low. The timing of the green flag going up on marijuana in the U.S. will probably depend on the outcomes of the 2020 presidential and congressional elections.
Currently, 33 states have given the green light to medical marijuana, and 11 states plus the District of Columbia have legalized recreational use.
4. The global hemp-derived CBD market is expected to see scorching growth
The hemp-derived cannabidiol (CBD) market is projected to soar from about $591 million this year to about $22 billion by 2022, according to the Brightfield Group. That's a whopping 37-fold increase in just four years -- and much faster than the projected growth for the marijuana market. The catalyst for these uber-powerful growth projections was the U.S. Farm Bill being enacted on Jan. 1, legalizing hemp production and hemp-derived products, including CBD.
CBD is a nonpsychoactive cannabinoid, found in both marijuana and its cannabis cousin hemp, that's been associated with various medicinal benefits, including pain alleviation. Hemp has a very low concentration of tetrahydrocannabinol (THC), the psychoactive chemical in marijuana responsible for users getting "high," and it's low enough to be considered negligible in hemp.
While several smaller companies are already involved in, or plan to enter, the hemp-derived CBD space, one company to watch is Canopy Growth. In January, Canopy announced it received a license from New York to process and produce hemp-derived products. On Canopy's recent earnings call, management said the company's hemp-derived CBD products should be available in the U.S. by late this year or in early 2020.
5. Several cannabis companies are profitable on an operating basis
Only four pure-play cannabis companies are profitable on an operating basis, according to Motley Fool contributor Sean Williams: Innovative Industrial Properties, Trulieve Cannabis, Harvest Health & Recreation, and Charlotte's Web Holdings.
Canadian companies Trulieve and Harvest are vertically integrated and they both operate dispensaries in the U.S. Trulieve has historically operated medical-marijuana dispensaries in Florida, but expanded into California and Massachusetts last year. Boulder, Colorado-based Charlotte's Web produces and distributes products made from CBD extracted from hemp.
6. A couple of cannabis players have huge cash hoards
Money can't buy you love (if you believe the Beatles), but for companies involved in a burgeoning new market, it can buy the ability to enter new geographical areas, and expand into new products or services.
Thanks to strategic partnerships with deep-pocketed companies, Canopy Growth and Cronos Group stand out among the growers because of their bulging cash balances. Canopy received $4 billion last fall when alcoholic-beverages giant Constellation Brands (STZ -0.70%) increased its ownership stake in Canopy to 38%. Cronos recently took in approximately $1.8 million from the tobacco giant Altria Group, which bought it a 45% stake in Cronos.
7. First and early movers have long-term advantages
Many of the companies currently involved in the cannabis space can be considered relatively early movers, if not first movers. Usually, first and early movers have a sustainable long-term advantage because they have a head start in building strong brand names, developing partnerships, and winning over customers before those consumers can develop loyalty to a competitor.
Investors fishing for a first mover might want to explore Canopy Growth or Innovative Industrial Properties (IIP). Canopy was founded in 2013, making it one of the earliest movers among growers. For context, Cronos was founded in 2012, Tilray and Aurora were started in 2013, and Aphria followed a year later.
Moreover, Canopy has won many races: first cannabis company in North America to be publicly traded, first cannabis-producing company to be listed on the New York Stock Exchange, and first Canadian marijuana producer to be approved to export dried cannabis to Germany.
IIP touts that it's "the first and only real estate company on the New York Stock Exchange focused on the regulated U.S. cannabis industry." (The New York Stock Exchange is owned by Intercontinental Exchange.) IIP is not only profitable, but also pays a dividend since it's a REIT -- yielding 2.09%, as of the market close on March 19.
8. Some cannabis stocks are gaining institutional support
Institutional support, or money from big investors like banks, generally helps power a stock over the long term. A stock might rocket higher for a while based solely on the exuberance among retail investors, but eventually, investments from big financial institutions will be needed to sustain further rises in stock price. Investors should monitor ownership data for their particular stocks.
The biggest outlier in this chart is Innovative Industrial Properties, with nearly 82% of its outstanding shares owned by institutions. Its amazing 233% one-year return (as seen in the second graph) can be attributed to institutions pouring money into it over the last year, raising IIP's institutional ownership percentage to 82%, up from just 16.3% at the end of February 2018.
Here's the same chart without Innovative Industrial to better illustrate institutional ownership changes among the other stocks:
Legal marijuana and hemp are still untested markets, but there is plenty of room for growth, especially among early movers, companies that are profitable, and companies with institutional investors. Potential investors should weigh all the risks along with the growth prospects for a particular marijuana or hemp stock before buying it.
If you decide you're comfortable allocating some of your own green into this sector, then make sure you know what you're helping grow, and how to monitor its continuing progress. And remember that when it comes to fledgling marijuana and hemp stocks, not to invest more money than you can afford to lose.