Please ensure Javascript is enabled for purposes of website accessibility

Read This Before You Buy Any Marijuana Stocks

By Sean Williams – Updated Nov 11, 2016 at 9:48AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The marijuana industry may be growing rapidly, but if you don't know these critical points, your investment in marijuana stocks could go up in smoke.

Image source: Pixabay.

This article was updated on Nov. 10, 2016, and was originally published on March 14, 2016.

It may not rank up there next to Social Security or Medicare, but marijuana received a lot of coverage this election season -- and for good reason.

According to the latest national poll from Gallup, 60% of respondents would like to see marijuana legalized. This is a new all-time high for Gallup's poll, and it's more than 30 percentage points higher than public responses fielded in Gallup's poll during the mid-1990s. Medical marijuana has an even higher approval rating, with a CBS News survey in April of last year showing that 84% of respondents want to see marijuana approved as a treatment for certain ailments.

What you need to know before buying marijuana stocks

With growing momentum, you might be intrigued enough to consider investing in marijuana stocks. However, before you go and do that, here's a list of some pertinent things you ought to know first.

Image source: Flickr user Bryan Rosengrant.

1. Most marijuana businesses are losing money

Despite ArcView Market Research estimating that legal marijuana generated $5.4 billion in sales in the U.S. last year, the vast majority of publicly traded marijuana businesses lost money. You might think that with growth in the industry exploding, losses would be irrelevant and overlooked by investors. However, all you need to do is take a peek at how clinical-stage, and money-losing, biotech stocks have been routed since the beginning of 2016 to understand that profitability and growth do matter over the long run.

2. Most marijuana stocks trade on the pink sheets

In addition to most marijuana businesses losing money, the vast majority of marijuana stocks trade on the pink sheets, or over-the-counter exchanges as penny stocks. Regulations on OTC exchanges have improved substantially in recent years, but the reporting standards still aren't on par with what you'd find with a company listed on the NYSE, Nasdaq, or NYSEArca exchanges. What this means for you is that finding pertinent, accurate, and up-to-date financial information, such as cash on hand, debt, cash flow, and so on, could prove difficult with most marijuana stocks.

3. Marijuana businesses face two inherent disadvantages

Investors have to remember that even though legal marijuana is expanding at a rapid pace at the state level, the marijuana plant remains illegal at the federal level. As such, marijuana businesses face two major disadvantages compared to normal businesses.

Image source: Pixabay.

First, even though marijuana is illegal federally, the IRS still expects marijuana businesses to pay federal income taxes. Here's the kicker: marijuana businesses aren't able to take normal business deductions, such as rent, because they're selling a substance deemed illegal by the federal government. In other words, marijuana business are paying tax on gross profits rather than net profits. Ouch!

The other issue is that few financial institutions want to deal with marijuana businesses because the substance remains illegal at the federal level, and many banks fear federal prosecution further down the road. This often means no access to checking accounts or lines or credit, creating a security problem, and stymying the industry's expansion efforts.

4. The 2016 elections will hold a lot of weight

Potential investors in marijuana stocks should also understand that the 2016 elections could tell the tale of where marijuana heads next.

With the elections now in the books, we know that Donald Trump is America's President-elect and that Congress will remain in hands of Republicans for the immediate future. As a generalization, the Republican Party tends to oppose the legalization of marijuana, as is evidenced by the fact that many of the remaining states that have not approved medical marijuana are traditionally "red" states. 

Image source: Disney-ABC Television Group via Flickr.

On one hand, Donald Trump noted during his campaign that he's 100% behind the idea of legalizing medical marijuana. He has not, however, come out in favor of recreational marijuana, choosing instead to wait and see how well or poorly certain states do in regulating their respective industries. 

On the other hand, rescheduling marijuana could have a few unintended consequences. Moving it to schedule 2 would effectively mean regulating marijuana as a pharmaceutical product, thus exposing its to the stringent regulations of the Food and Drug Administration. The FDA would have the power to OK marketing and packaging, regularly inspect grow and processing facilities, and it could require that clinical trials be run to confirm the purported medical benefits of marijuana. In short, expenses for marijuana companies could soar. 

5. Congress is in no rush to discuss marijuana legislation

Marijuana's approval rating may be soaring, but Congress itself is in no rush to make a hasty decision on marijuana.

What's the hold up? Primarily, lawmakers are waiting on more studies to emerge that will encompass marijuana's long-term safety profile. Decades of research have gone into analyzing the dangers of marijuana, but only recently has the focus turned to marijuana's possible benefits. Until a more complete safety profile is present, lawmakers are perfectly comfortable sitting on their hands.

6. The growth potential is enormous, if certain things happen

Finally, if certain things fall the industry's way, such as a rescheduling by the federal government, marijuana's growth could soar. ArcView Market Research believes that even without legalization, marijuana can grow at a compound annual growth rate of 30% between 2016 and 2020, resulting in $22 billion in legal sales by 2020. If this were to happen, marijuana stocks would indeed be an intriguing investment.

Marijuana stocks could have a lot of potential if the cards fall their way. However, there are no guarantees that any changes will be made at the federal level any time soon, if ever. Until such changes are made, marijuana stocks as a whole remain risky for a multiplicity of reasons, including, but not limited to, potential lack of financial transparency on OTC exchanges, unfair taxation, and minimal access to basic banking solutions. In other words, I'd suggest steering clear of this industry until the federal laws that govern marijuana are changed.

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.

The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Nearly 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/01/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.