A recent report by The Arcview Group showed that legalized marijuana is now the fastest growing industry in the U.S., posting a whopping 74% growth rate in 2014. Despite a widespread movement to legalize marijuana for both medicinal and recreational purposes across the country, though, the industry still faces some serious challenges on the legal front that investors need to understand.
So, to give investors a deeper look at some of the more pressing legal issues, I spoke with a leading expert on medical marijuana, Aaron Lachant -- an attorney with the healthcare specialist law firm Nelson Hardiman LLP.
Since 2009, Aaron and his associates have worked closely with businesses and investors in this space to ensure regulatory compliance with California state law. As such, he's uniquely qualified to provide the investing community with an overview of the biggest opportunities -- and risks -- across the legalized marijuana industry going forward.
With that mind, here are the key issues this top expert thinks investors need to know before investing in marijuana stocks.
Kicking off our conversation, I asked Aaron about his views on the biggest risks for investors in this highly volatile and still unproven industry.
Paraphrasing his response:
At the end of the day, everything remains illegal under federal law. Although the U.S. Dept. of Justice won't prosecute federal law right now, a change in president or attorney general could wipe out the entire industry overnight.
So, marijuana investors should definitely pay extremely close attention to the upcoming presidential election. While it's unlikely any candidate from either major party would openly endorse major changes in the law at the federal level, some candidates may, in fact, be eager to roll back the industry's recent advances toward widespread legalization and social acceptance at the state level.
And forthcoming federally oriented legislation might be the biggest opportunity, according to Aaron and his colleagues at Nelson Hardiman.
Marijuana might become a states' rights issue
What Aaron is referring to is a piece of pending legislation known as the Compassionate Access, Research Expansion and Respect States Act, or CARERS Act for short. This bill was introduced into the Senate last month by Rand Paul, Kirsten Gillibrand, and Cory Booker, with the aim of making marijuana a "states' rights" issue by rescheduling the drug from Schedule I to Schedule II. And only two weeks later, Steve Cohen and Don Young proposed a nearly identical bill into the House of Representatives, showing that marijuana legalization is indeed gaining momentum at the federal level.
If the CARERS Act were to pass, states could determine their own policies on medical marijuana without federal intervention. So, in states that have legalized cannabis, patients, doctors, growers, and vendors would essentially be immune from federal prosecution.
This pivotal bill would also remove current banking restrictions, arising from federal law on marijuana-related business, that have greatly hampered the industry's growth. Marijuana-based businesses often find it difficult to open even a simple bank account or access capital from reputable sources due to federal law that governs banking rules and regulations. The net result has been a fledgling industry burdened by huge logistical and financial hurdles.
Another interesting ramification of the CARERS Act is that U.S. research institutions would be allowed to pursue clinical work on the plant's latent medical benefits without having to go through mountains of red tape associated with Schedule I drugs. Indeed, this is perhaps the biggest reason why most medical marijuana research has been largely confined to ex-U.S. companies like the British-based GW Pharmaceuticals (NASDAQ: GWPH).
Stocks that may benefit or suffer from the CARERS ACT
Given the wide-ranging effects of such a piece of legislation, I asked Aaron for his view on which companies might benefit -- or suffer -- the most from the CARERS Act turning into law. And his answer was rather surprising.
According to Aaron, investors might want to avoid start-up companies at this point because this bill would de-risk the industry, presumably attracting major players with far more resources.
On the distribution-side, for example, Aaron thinks large drugstore chains like CVS Health, Rite Aid, and perhaps even Wal-Mart, could end up pushing out smaller, specialty distributors, despite their first-mover advantage.
Regarding this matter, Aaron said, "These large drugstores could just clear a shelf for medical marijuana products," implying that they already have the costly infrastructure in place to bring medical cannabis to the masses. That's an undeniably powerful competitive advantage, and one that smaller, start-up distributors may not be able to overcome very easily.
But that's not all. Aaron noted in our conversation that U.S. researchers would have a much easier time investigating marijuana's potential health benefits. Medical marijuana companies like GW Pharma would therefore lose their near-monopoly on this part of the market, which has presumably helped its share price to absolutely soar over the past two years:
Looking ahead, the CARERS Act would permit U.S.-based big pharma companies like Pfizer to pursue a marijuana-based clinical program without significant push-back from Federal regulators. That would be a nightmare scenario for GW Pharma, and its handful of midsized peers, working on marijuana-based medicinal products.
Summing up, this is a pivotal time in the movement to legalize marijuana. The CARERS Act, or similar legislation, could drive a major shift in the types of companies operating in this field. As a result, the current generation of mostly poorly-funded marijuana operations may get plowed under by this political sea change, making their stocks an extremely high risk proposition.
That's why large cap companies that are well-positioned to benefit from this shifting political and legal landscape -- like a CVS or a Rite Aid -- are probably much safer investing vehicles to gain exposure to legalized marijuana over the long term.