It's not often that an industry emerges that has flown under the radar of most investors despite its multibillion-dollar potential. Marijuana is one such industry.
The perception of marijuana is changing all over the United States, with practically every major poll showing that a slim majority of respondents favors the legalization of the still-federally-illicit drug. For the 23 states that have legalized medical marijuana and the four states that have also pushed through recreational-use legislation, it represents a new revenue stream that can help supply much-needed cash to the education, infrastructure, or whatever other government program would benefit. But for chronic or terminally ill patients, marijuana represents a new pathway of treatment. Not surprisingly, the favorability of medical marijuana is substantially higher than recreational marijuana in various polls.
10 things to know before you buy a medical marijuana stock
It's possible that medical marijuana and medical marijuana stocks could at some point be the fuel that pushes your portfolio higher. However, before you go out and buy your first medical marijuana stock, here are 10 things you really need to know.
1. You don't have many (viable) choices
The first thing investors will realize is that they don't have many trustworthy medical marijuana stock choices. The most obvious choice is GW Pharmaceuticals (NASDAQ:GWPH), a $2.2 billion biopharmaceutical company that's discovered more than five dozen cannabinoids from the cannabis plant. The other sizable company that could be considered a play on the marijuana industry is Insys Therapeutics (NASDAQ:INSY), with a market value of $2.4 billion.
Beyond these two companies, there are somewhere in the neighborhood of six dozen other marijuana stocks (both medical and non-medical) that investors can choose from, but most are traded on the over-the-counter exchanges. To be clear, the OTC boards are improving, but information on these boards can sometimes be tough to come by -- finding out what the company does or whether it even has a revenue stream, for instance, may not be possible.
2. None are profitable for the reason you believe
The next thing you need to know is that the medical marijuana stock you're considering probably isn't profitable, at least for the reasons you believe.
For example, Insys Therapeutics is very profitable, but that's squarely because of sales of Subsys, a sublingual mucosal spray designed to treat breakthrough pain associated with cancer. In the second quarter, Insys generated $77.6 million in product sales, and all but $0.9 million came from Subsys, which is not a marijuana-based compound. To proclaim Insys as a medical marijuana stock is almost a stretch. Make no mistake that pure-play marijuana stocks, like GW Pharmaceuticals, are losing money and may lose money for years to come.
3. A change in the federal government's stance is no guarantee
A majority of studies suggest that Americans have a favorable view of marijuana, but that doesn't mean the federal government will act anytime soon to legalize or decriminalize the drug on a medical or recreational level. President Obama has gone on the record as being intrigued at the experiment going on in a number of states at present, but pushed young adults not to get too wrapped up in the idea of legalizing marijuana on Capitol Hill. To summarize Obama's thoughts, there are simply bigger battles to be fought in Congress than marijuana.
4. Marijuana-based businesses have limited access to capital (at least for now)
If you're considering a medical marijuana stock, you should understand that access to basic banking services may not exist. For larger biopharmaceuticals like GW and Insys, this hasn't been an issue, but most banks have generally avoided marijuana-based businesses with a 10-foot pole. Because the federal government still views the plant as illegal, banks believe that lending to marijuana businesses, or even accepting deposits in the form of a checking account, could leave them exposed to criminal prosecution from the federal government. If medical marijuana-based businesses do not have access to capital, it could severely hamper their expansion plans.
5. They're facing a borderline unfair tax environment
Your medical marijuana stock could also be facing a particularly nasty tax situation within the United States. Even though select states have legalized marijuana, federal tax law still supersedes state tax law. This means section 280E of the U.S. tax code is the law of the land. Section 280E states that businesses involved in the sale of an "illegal drug" aren't allowed to take deductions when filing their taxes. The end result is that marijuana businesses are paying tax on their gross profits rather than net profits, and it's costing them a pretty penny.
6. Marijuana's medical safety is still largely unproven
More than a handful of clinical studies involving marijuana have demonstrated a positive medical benefit. There have been documented instances where marijuana or cannabinoids from the cannabis plant have helped ease symptoms associated with Alzheimer's disease, Parkinson's disease, type 2 diabetes, aggressive gliomas, and certain types of epilepsy.
However, for each positive marijuana study, there are plenty more that have examined its potentially adverse effects on the human body and mind over the long run. Establishing a safety record for marijuana is akin to putting a 50,000-piece puzzle together -- it doesn't happen overnight. This means it could take years before researchers established an acceptable safety profile for marijuana.
7. Marijuana businesses are in uncharted territory
Investors in any medical marijuana stock also need to understand that these companies are in completely uncharted territory. For many states, it's their first foray into allowing a federally illegal substance to be sold, and some of the businesses aren't really sure how to assess their consumer demand as of yet.
For example, Washington state growers (again, for medical and non-medical purposes) produced 13.5 tons of flowers in the first 12 months following the opening of the states' first recreational marijuana shop. Unfortunately, only 10 tons were purchased by consumers. Some of the excess can be used in oils, but the consensus here is that growers, processors, and retailers really don't understand their customer base (and demand) yet.
8. The 2016 elections will have a big bearing on the industry
Investors need to be aware that the upcoming presidential and congressional elections in 2016 could have a major impact on the sector. A presidential candidate that doesn't favor marijuana's expansion, or a Congress that remains apathetic toward marijuana, could be bad for the industry as a whole. On the flip side, a marijuana proponent in the Oval Office could be a boon for the industry. We won't know anything for a little more than a year, but be aware that the outcome of this election is extremely important for medical marijuana stocks.
9. New industries have a tendency to outrun their valuations
Although it's a bit of a generalization, investors should be aware that revolutionary sectors have a tendency to get ahead of themselves before they really take off. We've witnessed overzealous investors push stock valuations through the roof before only to be sorely disappointed shortly thereafter. Genome-analysis companies, 3-D printing, and near-field communication developers are all examples of sectors that were pumped up well in advance of the products actually delivering tangible profits. That could be the case with the medical marijuana stock you may be considering.
10. The market potential is enormous
Lastly, the market potential of the medical marijuana stock you're considering is probably enormous. GreenWave Advisors has suggested that an across-the-board legalization of marijuana could lead to an industry worth as much as $35 billion. Even if marijuana isn't legalized across the board, the research firm indicates that select state legalizations in the coming years could push the market value of the green plant to as high as $21 billion by 2020.
To quickly summarize these points, marijuana stocks could offer incredible growth over the long term, but they first have to overcome a veritable sea of hurdles. As a well-informed investor, the decision of whether to invest in a medical marijuana stock is now up to you.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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