Few investors are as highly regarded -- and as successful -- as the Oracle of Omaha, Warren Buffett. In just over six decades, Buffett's investing strategy has grown his wealth from about $10,000 to more than $71 billion. Not too shabby, right?
The secret to Buffett's investing strategy is really no secret at all. In fact, Buffett's primary path of success has merely been to locate high-quality businesses and stick with them over the long term. He understands that time is his most powerful ally and allows dividends and stock appreciation to work their magic over years and decades. This has transformed his conglomerate, Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), into a $350 billion, highly diversified juggernaut.
Generally speaking, Buffett is a straight shooter. He likes to buy established brands whose products and services could practically sell themselves regardless of how skilled the management team happens to be. Buffett likes products with lots of demand around them -- so it's worth considering whether there could be room in Warren Buffett's portfolio for marijuana stocks.
On the surface there's plenty of potential in the marijuana sector. The most bullish long-term outlook comes from GreenWave Advisors, which recently released a report predicting that the legal marijuana market could be worth as much as $35 billion by 2020 if the federal government legalized the drug. Even if the U.S. Drug Enforcement Administration doesn't change its tune on marijuana, GreenWave forecasts that 37 states will legalize marijuana for medical purposes by 2020 and a dozen states will legalize recreational use of the drug. This timeline predicts a $21 billion market value for legal marijuana by 2020.
Certainly a market that could grow from just a few billion dollars to $21 billion-$35 billion in six years would attract Buffett's attention, right?
Warren Buffett would probably like this
On one hand, marijuana stocks do offer a couple of factors that Buffett looks for in the companies he buys.
For starters, Buffett relies on long-term trends to dictate his buying or selling habits. He tends not to worry about a bad quarter or two from one of his companies if the businesses is positive over the long term. Banks, insurers, soft-drink makers, and so on are all set to benefit from a growing population that needs access to cash, protection from disasters, and something to drink. Meanwhile, an October 2013 poll from Gallup, which showed more people in favor of marijuana legalization than opposed, strongly suggests the marijuana movement might be unstoppable on a state level.
Marijuana could also see inelastic demand and pricing regardless of how well or poorly the U.S. economy is doing. Buffett loves buying stocks that offer the potential to outperform in any environment.
Yet, Buffett would also disapprove of this
However, there are also quite a few reasons why Warren Buffett's investing strategy might not be a good match with marijuana stocks.
First, Buffett likes to buy into companies that have natural "moats," as calls them. You might know them better as barriers to entry. While rules and regulations certainly limit the number of marijuana retailers, and patents would protect any drugs that could be developed by cannabinoid researchers GW Pharmaceuticals (NASDAQ:GWPH) and Insys Therapeutics (NASDAQ:INSY), entering the marijuana industry isn't too difficult. All you need to do is look around at the myriad of unqualified penny stocks with paper-thin business models to understand that the barriers to entry are minimal.
Second, there aren't many viable ways today to play the growth in the marijuana market beyond its medical aspects (thus why I mentioned GW Pharmaceuticals and Insys above). The problem there is Buffett and Berkshire have little to no patience when it comes to keeping up with the ins and outs of clinical trial data. Buffett much prefers that the businesses he buys are easy to understand from the get-go, and that they maintain their growth prospects for years or decades. The finite patent life of drugs, compounded with the need to stay up to date on GW Pharmaceuticals' and Insys' pipelines, would likely keep Buffett away from these plays.
Third, Buffett wants to see a consistent history of profitability and cash flow. Though Insys is profitable, that would preclude the predominantly clinical-stage GW Pharmaceuticals, as well as practically every penny stock associated with the marijuana industry, because they're all losing money.
Finally, I suspect the biggest concern of all is the ongoing legal cloud that hangs over the marijuana industry. Even with 23 states (and Washington, D.C.) approving medical marijuana, and four states (plus D.C.) passing recreational marijuana laws, there's no guarantee the federal government, which still classifies marijuana as a schedule 1 drug, won't take a more active role in regulating pot in the future.
Could Warren Buffett's investing strategy incorporate marijuana?
In spite of its rapid growth prospects and favorable opinion in polls, I believe the idea of marijuana finding its way into Buffett's portfolio is nothing more than a pipe dream.
Buffett would demand greater investing diversity than just the two companies listed above. Additionally, marijuana businesses would need to show a steady history of profitability and strong cash flow in order to attract the Oracle. Dividends are practically a necessity for a Buffett stock, and regular stipends all start with strong cash flow. Finally, the legal questions surrounding marijuana's long-term future would have to be resolved.
For now, I suspect marijuana will remain a highly emotionally charged investment, and I would strongly suggest anyone considering marijuana for their portfolio weigh their own risk tolerance and investment time horizon carefully before taking the plunge.