Federal marijuana legalization is getting more attention in the U.S., and it's now more about when, not if, the change will come to pass. Senate Majority Leader Chuck Schumer released a draft bill this month, the Cannabis Administration and Opportunity Act, that could federally legalize pot and remove many of the barriers multistate operators (MSOs) in the cannabis industry face today -- including a lack of access to banking and the inability to transfer products across state lines. It's a long shot, as there have been question marks around just how far President Joe Biden wants to go on marijuana reform, and outright legalization may not be on his agenda.
But some kind of reform is a safe bet now that the Democrats are in control of the House and Senate. And cannabis companies could thrive when it happens, leading to some great returns for investors. However, not all pot stocks will be great buys, and the biggest mistake cannabis investors could make right now is holding the wrong marijuana companies in their portfolios.
MSOs will stand to benefit the most from marijuana reform
Many times when there is bullish news relating to marijuana legalization, it is Canadian pot stocks like Aurora Cannabis or Canopy Growth (CGC -4.82%) that surge in value, rather than U.S.-based businesses that will see the most benefit. While a legal U.S. pot market would open the doors for Canadian companies to do business south of the border, they are also at significant disadvantages as they aren't fully up and running there. Canopy Growth, which has a pending deal with Acreage Holdings that it can close when marijuana legalization takes place, will be in the best position to capitalize on the new opportunity, but it will take time to sort out the logistics. Plus, the company has been burning through cash and accumulating losses, and rapid expansion could exacerbate those problems.
Meanwhile, U.S.-based like Trulieve Cannabis (TCNNF 0.51%) and Curaleaf Holdings (CURLF -2.20%) that simply need the green light to transfer their products across state lines will instantly benefit from economies of scale they've never before had access to. Rather than acquiring businesses in states they want to sell their products in, they can simply secure deals with retailers and ship products there. Both businesses are already generating positive cash flow from their operations, and Trulieve has posted an accounting profit in each of its past four quarters. Curaleaf remains in the red, but it is posting pre-tax profits (Canopy Growth isn't).
Another reason these stocks could be poised for some great returns is they will have access to a greater pool of investors. Currently, Trulieve and Curaleaf both trade on secondary exchanges -- the over-the-counter market and the Canadian Securities Exchange. That's because they can't trade on major exchanges like the New York Stock Exchange, the Nasdaq, or the Toronto Stock Exchange due to the illegality of marijuana in the U.S. Once that changes, they can list on those exchanges, and investors there won't need to settle for non-MSOs or Canadian pot stocks -- which could quickly become second-rate options for cannabis investors.
Other businesses will also benefit from legalization in the U.S., including real estate investment trust Innovative Industrial Properties and GrowGeneration, which provides growers with the tools they need to grow cannabis (and other plants). However, because these businesses don't touch the marijuana plant itself, they don't face the same restrictions MSOs do. While they will benefit as more companies enter the industry, their potential upside will be much more limited.
Invest in an ETF if you aren't sure which stocks to choose
You could obtain some great returns from Trulieve, Curaleaf, and/or another multistate operator once marijuana is legal in the U.S. and the floodgates open up. And if you aren't sure which stock may be the best buy, you can sacrifice some potential returns and invest in an exchange-traded fund (ETF) to help simplify that decision. The AdvisorShares Pure US Cannabis ETF (MSOS -0.57%) is made up entirely of U.S.-based marijuana stocks, with MSOs accounting for 86% of its total weight (Curaleaf and Trulieve are two of its top three holdings).
With this ETF, you can take the guesswork and analysis out of the equation and ensure that you have exposure to the top MSOs in the country. Other cannabis ETFs offer a broader mix of stocks, generally including Canadian-based companies that could fall out of favor with investors when U.S. legalization happens, limiting potential returns.
The cannabis industry is growing, and now could be a great time to invest
According to cannabis research company BDSA, the U.S. pot market will be worth $34.5 billion by 2025 and will grow at a compound annual growth rate (CAGR) of 18%. Although that's technically less than the Canadian market's estimated CAGR of 26%, the industry north of the border will only be worth $6.1 billion by that time; that doesn't leave as much market share to go around for cannabis companies. And the U.S. market will only get larger as more states legalize pot.
Even if it takes multiple years for marijuana legalization to happen in the U.S., investing in a top MSO could pay off significantly for investors. Missing this opportunity could be a huge mistake, one that cannabis investors will likely end up regretting years from now.