The cannabis industry's growth potential is one of the key reasons investors have been buying up pot stocks in recent years. One of the most recent estimates, by research company Fortune Business Insights, projects the global cannabis market will be worth more than $97 billion by 2026. Estimates like this sound impressive and are very effective in attracting investors. But investors shouldn't be quick to rely on these numbers for a couple of important reasons.
1. There are too many variables to account for
Predicting how large the cannabis industry will become in the future is a very challenging task. In making these calculations, analysts need to consider which geographic markets will fully legalize pot, and estimate how large those particular markets will be, while also accounting for country-specific variables that might affect the industry's growth.
Even just forecasting how large the U.S. market will be is a big enough challenge on its own. Federal legalization of marijuana may seem inevitable, but when exactly that will happen is a big question mark, and next year's election could have a significant effect on that. While some presidential candidates are in favor of legalizing marijuana, others are not.
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That's why these estimates for the cannabis market, whether global or domestic, can be very unreliable since there are so many assumptions involved in them. Investors also don't know how sound the logic is in coming up with these numbers, and that's why there can be significant variations across estimates.
2. Estimates vary wildly from one company to another
According to ResearchAndMarkets.com, the global cannabis market will hit more than $150 billion by 2027, dwarfing the aforementioned estimate of $97 billion. Investment bank Jefferies Group projects that the industry won't be worth $150 billion even by 2029 -- when it estimates the global cannabis market will have a value of $130 billion. Meanwhile, BDS Analytics estimates that in the shorter term, consumers may spend more than $40 billion on cannabis by 2024.
Investors don't know the methodology involved in these estimates, and why there's such a significant variance from one company's calculation to another's. And understanding the methodology is imperative in order to gauge which estimate is more accurate and reliable. While these numbers appear impressive and suggest a lot of growth is available in the global market, any number of variables could quickly derail these estimates, given how complex these models to predict the industry's size would have to be.
BDS Analytics cut its forecast for the Canadian market in April as the launch of the cannabis industry didn't go as well as analysts expected. Previously, the research company estimated the Canadian market would be worth $5.9 billion by 2022. Its revised estimate now projects a market size of $5.2 billion, and that will be by 2024. Not only is the total market size smaller, but it'll take longer for the industry to grow as well. This is just one market estimate and on a global scale, adjustments will be much more significant in size. That's why making projections for the global cannabis market may not be all that worthwhile or reliable.
What does this mean for investors?
There's no denying there will be significant growth in the cannabis industry for many years, but investors need to exercise caution when investing in a stock for its growth potential. For instance, Aurora Cannabis (ACB +0.43%) has been very aggressive in growing in many parts of the world. It has a presence in 25 countries, and its latest investor presentation projects the "total global cannabis opportunity" to be worth around $200 billion, which includes medical, consumer, and wellness markets. This vague claim cobbles together four estimates for different markets and doesn't specify by what year this $200 billion milestone is expected to be met.
There's no guarantee the market will grow to that size, and it's anyone's guess how large of a market share Aurora will command. There's been no shortage of bullishness and excitement in the cannabis industry about what the future may look like, and it becomes dangerous for investors to buy shares of a company based on an optimistic vision of what the market will look like years from now.
Investors are better off looking at what exists here and now, or at least the near future, not based on bullish growth numbers that the industry may never reach. Aurora may very well become a dominant force on the world stage years from now. However, with $294 million Canadian dollars in revenue over the past four quarters, it still has a long way to go.
While it's OK to pay for growth, investors shouldn't value a company highly simply because of what the industry's size may -- or may not -- grow to. Marijuana stocks are still very risky investments today, and investors need to be careful by relying on valuation multiples to help assess whether a stock is a good buy or not, rather than astronomical market estimates.
