Few industries are expected to generate the green over the long run quite like the cannabis industry. With Canada legalizing recreational marijuana in October, and two-thirds of the U.S. allowing physicians to prescribe medical cannabis (11 states have also legalized adult-use weed), it's easy to see how North America has become the breeding ground for growth in the legal pot industry.
Just how big the marijuana industry could grow remains up for debate. While "tempered" estimates on Wall Street foresee $50 billion in worldwide sales by 2029, representing a better than fourfold increase in sales from 2018, other forecasts call for as much as $200 billion in global sales in a decade. Such forecasts assume the full legalization of cannabis at the federal level in the United States. The U.S. is expected to be the crown jewel of the cannabis movement, in terms of annual sales.
Improved favorability toward cannabis, coupled with ongoing legalization efforts and very friendly growth forecasts from Wall Street, have all played a role in pushing pot stock valuations higher over the past couple of years.
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The one thing you need to know if you own, or plan to own, cannabis stocks
However, investors have learned the hard way since the beginning of April that cannabis stocks don't go straight up. Following a first quarter that saw more than a dozen popular pot stocks surge by at least 70%, we witnessed more than two dozen cannabis stocks give back at least 20% of their value during the second quarter -- and much of this weakness has carried over into July.
This recent drop raises an important point that all marijuana stock investors, and prospective investors, need to understand about this industry (and any next-big-thing investment for that matter). Namely, that every industry, including cannabis, needs time to mature.
I know what you're probably thinking: That the marijuana industry is already fairly mature since a black market has existed for decades. But keep in mind that the black market doesn't have to contend with the licensing process for cultivation, processing, or sales, or pay excise taxes as they do in Canada and select legal U.S. states.
Further, illicit cannabis models usually aren't scalable given the fact that they're designed to avoid detection by law enforcement, whereas legal-channel weed businesses are pretty much always built to be scaled. The entire process of moving marijuana into a trackable seed-to-sale platform is a work-in-progress, and that means there are going to be bumps in the road and disappointments along the way, even if Wall Street's long-term growth forecasts prove accurate.
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Growing pains are the expectation, not the exception
For example, consider the supply chain woes that are currently wreaking havoc on Canadian pot stocks. When the year began, regulatory agency Health Canada had a backlog of more than 800 cannabis licensing applications to review, yet has approved a grand total of less than 200 since 2013. Even with newly implemented regulations designed to dwindle its backlog, it's going to take time before Health Canada has an opportunity approve enough cultivation, processing, and sales licenses to meet domestic demand.
Because of this supply bottleneck, growers like Canopy Growth (CGC +21.05%) have suffered. Make no mistake, some of Canopy's issues are self-inflicted, with rapidly rising share-based compensation and expenditures tied to its aggressive acquisition history. But Canopy's fiscal fourth-quarter report featured a sequential decline in both recreational and medical marijuana sales in Canada that almost certainly wouldn't have occurred if supply chain problems weren't persistent throughout the country.
In the U.S., excise taxes have been more of a problem than oversupply or weed shortages. For instance, some locales in California are dealing with combined tax rates of close to 45%, once state and local taxes are added to the retail excise tax and the wholesale tax on growers. This makes it veritably impossible for legal-channel weed to compete with the black market on price.
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How do we know this to be the case? Just take a look at the third-quarter operating results from MedMen Enterprises (MMNFF +0.00%), which recently announced that it would be opening a 15th retail store in the Golden State, 11 of which are located in Southern California. Despite reporting rapid sales growth, MedMen noted that organic growth in its existing California locations was a meager 5% from the sequential second quarter. Although oversupply could be hurting the per-gram price charged for legal cannabis in California, MedMen's weaker results look to be predominantly tied to a resilient black market fueled by high tax rates.
And, of course, we can't overlook the scandals. Earlier this month, the industry was rocked by CannTrust Holdings' (CTST +0.00%) admission that it had grown marijuana in five unlicensed rooms between October and March (these rooms were licensed by Health Canada in April 2019). CannTrust wound up having 12,700 kilos of inventoried product placed on hold following this admission, and is currently awaiting word from Health Canada as to its punishment. Chances are that CannTrust won't be the last scandal we see in the pot industry.
Stay the course and think long-term
So, how does a marijuana stock investor succeed in an industry that's still gaining its footing? The simple answer is that you have to think long-term and potentially purchase a basket of companies in the industry.
Whether you're buying marijuana stocks, or investing in established industries or sectors, the data tends to be pretty consistent: Timing the market is virtually impossible to do with any success over the long run. If the legal pot industry does grow to $50 billion, $100 billion, or even $200 billion in annual global sales, there are undoubtedly going to be winners. But we're talking about sales figures that are perhaps 10 years down the road, and a lot could happen between now and then.
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You should also be investing in the marijuana industry with the understanding that you could lose a substantial portion of your capital. As a nascent industry, it's still unknown which companies will be long-term winners. In other words, the pot stocks with the largest market caps today aren't guaranteed to be the biggest winners over the long run. That means your best game plan to invest in this industry is to buy a basket of direct and ancillary players, and to ensure that you devote no more money to pot stocks than you're willing to lose.
Yes, the pot industry can deliver the green to investors over the long run. Just understand that it's not going to happen overnight.
