Amidst its historic growth spurt prompted by legalization and decriminalization at the state level, the cannabis industry is continuing to mature and change. As in every industry, the best companies are adapting and using the changing conditions to their benefit, whereas the weakest are struggling in the face of new challenges.
If you want to pick the best cannabis stocks for your portfolio, you'll need to understand what's going on with the industry and why it matters. Follow along with me, and I'll show you which three trends are likely to push strong stocks to soar and lesser stocks to fall.
1. Rising emphasis on cultivation yields
For most cannabis companies, the cost of growing cannabis is a big concern. The less money that a business spends to produce one gram of marijuana, the stronger its margin will be, because it won't need to nurture as many individual cannabis plants to get the same yield. Therefore, finding ways to milk more yield out of each plant is key, and companies that are successful will have an easier time competing as a result.
Some cultivators have turned to high-yield farming techniques like crop steering, which uses a combination of careful trimming and intentional changes to the amount of light and heat received by the plant in order to keep it in the most productive phase of its growth cycle. Others have continued the age-old tradition of breeding highly productive plants together to make new cultivars. And others still have turned to commercial solutions like those offered by 22nd Century Group, a biotech that uses genetic engineering to create higher-yielding cannabis plants.
Moving forward, expect the cannabis industry's winners to lean more and more on high-tech solutions like 22nd Century's. But investors should remember that when it comes to efficiency-improving techniques, the proof of the pudding is always in the eating. Many cannabis companies are quick to tout their sophisticated cultivation operations, even while their cost of goods sold (COGS) may be high as a percentage of revenue. Look for cultivators with falling COGS over time, and you'll likely be onto a few winners.
2. Intensifying competition in hot state markets
Though adult-use marijuana isn't legal in every state in the U.S., there are quite a few states where it is. In 100% of the states with adult-use cannabis, medicinal cannabis is legal too. That means companies that compete in those states can serve both the medicinal and the recreational use markets at the same time, making vastly more revenue in the process. So there's a substantial incentive to do business where the markets are both larger and more permissive.
Of course, these incentives also attract competitors. Major markets like California, Illinois, Massachusetts, Pennsylvania, and Florida are served by a slew of different sellers. Green Thumb Industries and Curaleaf both compete in all of the above states, yet neither bothers with places like South Dakota, even though the law permits adult use.
Expect more competitors to keep piling into the regional markets where there is proven and hot demand. The businesses that can succeed in those crowded markets won't have a problem expanding elsewhere as regulations allow. And think twice before investing in companies that are competing only in state markets where nobody else dares to tread. If competition ever shows up, there might not be room at the table for two.
3. Experimentation with new product types
I don't think that it's strictly necessary to make innovative new products when it comes to getting consumers to buy marijuana. Much like with the beer industry, people have their favorite formats, brands and flavors of cannabis. Still, it's true that putting a twist on an existing concept can be a great way to differentiate a product from the competition. And that's exactly what some of the more enterprising cannabis companies are doing.
Take MariMed's (MRMD -0.67%) plans to make a cannabis-infused ice cream, for example. Marijuana edibles are nothing new, yet to my knowledge, MariMed is the only public cannabis company that will offer edibles in the form of ice cream. Thus, it'll be able to capture revenue that nobody else can.
The trick will be whether that additional revenue will be worth the cost of accessing it, and the only way to find out is to eventually check out the earnings reports. Even if MariMed's ice cream isn't a hot seller, another business' experiment with a new product type might well be. Investors should expect management teams to heavily emphasize the most successful forays into the unknown -- and be aware that copycats will be all but guaranteed.