The cannabis industry has taken a beating in recent years. Although in the past there has been a lot of hype and excitement around pot stocks when there was more hope surrounding the possibility of U.S. legalization, that optimism has since faded.
Investors have been significantly discounting pot stocks as their financials have been underwhelming. In the long run, that means there could be a lot of long-term gains to be made here given the industry's growth potential. But it's not a slam dunk -- those who buy and hold these stocks will be taking on quite a bit of risk.
No clarity about when federal legalization will happen, if ever
Analysts at MarketsandMarkets Research project that between now and 2027, the global cannabis market will grow at a compound annual growth rate of 24% reaching a value of more than $82 billion. If marijuana companies can achieve that level of annual growth, they would make for incredible investments to hang onto for the next several years.
Many of these types of estimates, however, make optimistic assumptions about the timeline for legalization that investors simply cannot rely on. While more U.S. states are likely to legalize marijuana in the future or expand from medical use to adult recreational use, full federal legalization may not happen for years, if ever.
In the meantime, losses continue to mount
The longer that there is no movement in Congress on legalization, the longer marijuana companies will struggle to generate growth and stay out of the red. For example, while multi-state operator Curaleaf Holdings (CURLF -0.53%) has reported positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the past, it has been racking up net losses. And those losses have been getting deeper in recent quarters.
CURLF Net Income (Quarterly) data by YCharts.
And while new legal marijuana markets opening up have given it sales boosts in the past, the chart below shows how quickly its growth rate has plunged to just the single digits.
CURLF Revenue (Quarterly YoY Growth) data by YCharts. YOY = Year over year.
Those companies that survive could prove amazing investments
If federal legalization were to pass, there would be opportunities for significant economies of scale for producers such as Curaleaf, letting them cut their unit costs and potentially become profitable.
The risk is that many of today's cannabis businesses simply may not be around by the time those opportunities materialize. Although Curaleaf is a large operation today, and one that should be around in a few years, just how big or strong it will be down the road is a big question mark. The company has been scaling back, and it recently announced it will shut operations in California, Colorado, and Oregon.
A quick look at how poorly big players such as Canopy Growth and Aurora Cannabis have performed in recent years shows just how bad things can get. They, too, have been slashing costs and reducing their operations with the intent of improving their financials -- and those moves haven't paid off. Those two Canadian marijuana producers were once seen as industry leaders, but they have continually struggled with profitability, and their share prices have fallen by more than 85% over the past three years.
Those companies that are able to perform well and dominate the niche when federal legalization takes place -- or at least, do so a few years from now when the economy should be in better shape -- could be amazing investments. But predicting which cannabis companies will thrive is no easy task. And there's a real prospect that they all could struggle.
Should you invest in pot stocks right now?
While Curaleaf trades at less than 2 times revenue and looks like it could be a great buy, pot stocks are only suitable for investors with a high tolerance for risk. Considering some of the mammoth share price declines that companies in the industry have experienced, these are the types of investments you need to be able to afford to just leave alone for many years. If you think you may need to make use of the funds you're investing in the near to medium term, you'd likely be better off opting for safer stocks, because there's a lot of doubt hanging over the cannabis industry, and there's no clear indication of when pot stocks might recover.
