There's a growing movement for marijuana legalization in the U.S. and around the world. And a key part in winning regulators over is in showing them that the industry can be trusted to govern itself. However, the problem for the industry is that there's too much excitement surrounding its growth prospects, and this is when companies sometimes lose sight of everything else.
Here are a couple of examples where the industry's been doing itself more harm than good.
1. Making claims that aren't accurate or backed by strong data
Patients take cannabidiol (CBD) for its health benefits. Cannabis company GW Pharmaceuticals (GWPH) has benefited from strong demand for its Epidiolex drug, which can treat children with two rare forms of epilepsy -- Lennox-Gastaut syndrome and Dravet syndrome. The U.S. Food and Drug Administration (FDA) approved the drug in 2018. It's the first and only cannabis-based drug approved by the FDA.
The growing popularity and acceptance of Epidiolex has led to significant growth for the company. In 2019, its sales totaled $311.3 million, up from just $12.7 million in the previous year. And during the first quarter of fiscal 2020, sales of $120.6 million were triple the $39.2 million that GW generated in the prior-year period.
There could be even more growth for the company now that the European Commission also approved the drug, a decision that's valid in all the countries in the European Union.
And so there's a lot at stake for companies to convince consumers that CBD is helpful. But the problem is that in some cases, companies have been making claims that could be misleading. In November, the FDA sent out warning letters to 15 cannabis companies that were in violation of its rules, ranging from marketing products as dietary supplements, to adding CBD to food, and to simply making unapproved claims.
Multistate cannabis operator Curaleaf Holdings (CURLF -0.40%) received a warning letter last July, with the FDA noting several instances where the company was making unapproved claims. Among the claims the FDA alleged Curaleaf was making was that CBD could be effective in treating Parkinson's disease and Alzheimer's, and that it "was effective in killing human breast cancer cells."
While there may be small-scale studies where a correlation's evident between CBD and a particular disease, one of the problems with cannabis research is that in many cases, it's far from conclusive, and claiming otherwise is not a smart business move.
2. Not doing enough to avoid marketing to children
The one thing that there's general consensus on in the industry is that pot should be off-limits for kids. But that can be a problem when it comes to edibles. Cannabis edibles often look similar to candy, which of course appeals to children.
More egregious examples of the industry's recklessness have happened in the branding department. Last year, a Canadian animation studio sued a dispensary in Oklahoma for infringing on its logo. The Treehouse Dispensary was using an image that resembled Treehouse TV, a channel that airs children's programming in Canada. The animation studio won a default judgment against the cannabis company.
More recently, in Canada, a Vancouver-based dispensary got into trouble for using a name and logo similar to popular toy company Toys "R" Us, called Herbs "R" Us. A judge ordered the dispensary to destroy anything that had the offending logo on it and pay damages of 30,000 Canadian dollars to the toy company.
Even if the stores wouldn't have sold their products to children, these instances demonstrate that pot companies aren't making serious attempts to limit their advertising and marketing of cannabis to adults.
Why should investors care?
Investors may scoff at these issues, believing they're just legal problems that any industry faces. But it's indicative of the industry's maturity and early growth stages. The aggressive pursuit of sales at all costs can encourage companies to take shortcuts, such as stretching marketing claims beyond what's accurate or legal. It's symptomatic of why many cannabis companies struggle to become profitable -- because their focus is on the top line rather than on the bottom line and having a healthy operation in place.
Further, the industry's public image can go a long way in shaping attitudes that are crucial in moving legalization forward. These examples are reminders of how far the industry still has to go in legitimizing itself and winning over the electorate.
Investors should care about these issues because the longer the industry's seen as high-risk, the more speculative and volatile it'll be. And that makes pot stocks unattractive buys for long-term investors seeking stability and predictability in their returns.
While these problems won't take away from the success that a company like GW's enjoyed thus far, the industry's image certainly isn't doing the stock any favors. Even though GW has achieved incredible success over the past year, the stock's still down more than 25% in the last 12 months. It's better than the 60% decline of the Horizons Marijuana Life Sciences ETF, but it's nowhere near the positive 7% returns that the S&P 500 has generated.