Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

2 Friendly Reminders About Investing in Marijuana Stocks

By Sean Williams - Nov 13, 2019 at 7:21AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Cannabis stocks are down, but they're probably not out.

The expectation has long been that marijuana would be among the fastest-growing industries in the world over the next decade. We've already witnessed global cannabis sales more than triple over the past four years, and know that tens of billions of dollars in sales are undertaken annually in the black market. The demand is there -- it's simply a matter of continuing to legalize in new markets, and coercing consumers to purchase via legal channels.

Of course, the cannabis investment thesis has taken a big hit in recent months, and it has some folks questioning whether marijuana stocks can really deliver the green at all.

A gloved person uses scissors to trim a cannabis flower.

Image source: Getty Images.

Has the "green rush" investment thesis gone up in smoke?

To our north, Canada has been hit by a variety of regulatory issues that have led to supply problems throughout much of the country. Health Canada, the agency tasked with approving cultivation, processing, and sales licenses, entered the year with more than 800 applications on its desk for review. It's simply been unable to approve these applications quickly enough, leading to lengthy wait times for growers to get their products to market.

By a similar token, certain Canadian provinces have been slow to grant the go-ahead to physical dispensaries. Ontario, a province of 14.5 million people, has just 24 retail locations at which to purchase legal marijuana at the moment. This is helping to steer some consumers to the black market.

In the U.S., high tax rates and slow dispensary rollouts in certain states are to blame for cannabis-industry weakness. California, the most prominent marijuana market in the world, can hit consumers with an aggregate tax rate of as much as 45% on recreational pot. This includes state and local taxes, a 15% excise tax rate on recreational weed, and a wholesale tax on dried flowers or leaves. Once again, the end result is a flourishing illicit market.

While these recent problems might cause some folks to shy away from the pot industry, there are two friendly reminders about investing in marijuana stocks that I feel are worth passing along.

A visibly frustrated businessman puts his hands up in the air as he reads material from his laptop.

Image source: Getty Images.

1. Growing pains are a natural part of any "next big thing" investment

First of all, growing pains were fully expected within the marijuana industry.

Over the past quarter of a century, investors have witnessed a flurry of "next big thing" investments take shape. The rise of the internet, business-to-business commerce, genome decoding, blockchain, and 3D printing are examples of hot trends that investors latched onto. However, none of these investment trends were able to hold their parabolic valuation gains, because investor expectations for such trends always outpace reality.

The thing with the "next big thing" is that, typically, there's no precedent. This makes it incredibly difficult for even seasoned Wall Street analysts and investors to predict what sort of challenges an industry will encounter. In June 2018, pretty much every Wall Street analyst was counting on oversupply being Canada's biggest concern. Yet here we are in November 2019, and growers simply aren't able to get anywhere near enough of their product in front of consumers in retail stores. It's impossible to know ahead of time what sort of growing pains a hot investment trend will encounter.

Mind you, this doesn't mean the cannabis industry can't meet lofty global sales expectations in 10 years' time. It's just going to be a bit bumpier than the pie-in-the-sky forecasts had portended.

Four vials of cannabidiol-rich liquid are lined up on a counter.

Image source: Getty Images.

2. There's more to marijuana stocks than just growers

Sure, marijuana stocks have been awful investments of late, but there's more to the industry than just buying the four or five most popular Canadian growers. If you're willing to do a little homework, you'll find ways to avoid a lot of the unpredictability, supply-chain problems, and excess taxation that have plagued the North American weed industry.

For instance, investors could consider purchasing an extraction-services provider like Valens GroWorks ( VLNCF 8.49% ). Valens signs contracts with hemp and cannabis producers in Canada to process their biomass for resins, distillates, concentrates, and targeted cannabinoids that can be used in high-margin derivative products. These derivatives are a must-have for any pot grower, placing Valens' third-party services in high demand.

Furthermore, Valens' contracts are typically for two or more years. It has a deal in place to process hemp and cannabis biomass for HEXO, totaling 80,000 kilos in aggregate over two years, and will do the same for Tilray, with a target of 60,000 kilos per year. This creates highly predictable levels of cash flow for Valens GroWorks.

Another option would be for investors to consider U.S. cannabis stocks with minimal exposure to high-tax states. Take Trulieve Cannabis ( TCNNF -0.52% ) as a good example. Trulieve Cannabis has focused almost entirely on opening retail locations in Florida; it recently opened its 38th store in the Sunshine State. And it's one of the few cannabis stocks to be profitable on an operating basis. Even though Trulieve does have minimal exposure to California through an acquisition, its focus on Florida has proved critical to keeping its operating expenses low.

The point is: There are plenty of attractive marijuana stocks to choose from, beyond just Canadian growers.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Trulieve Cannabis Stock Quote
Trulieve Cannabis
TCNNF
$24.87 (-0.52%) $0.13
The Valens Company Stock Quote
The Valens Company
VLNCF
$3.49 (8.49%) $0.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
633%
 
S&P 500 Returns
140%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/07/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.