This article was updated on February 8, 2017, to reflect changes in the marijuana marketplace. It was initially published on May 13, 2016.

Marijuana legalization momentum accelerated into the November 2016 elections, and that resulted in significant wins for the pro-marijuana movement. In all, voters in eight states passed ballot propositions that cleared the way to legal medical or recreational marijuana markets.

This outcome might have you considering investing in marijuana stocks. If so, you're not alone. The market for marijuana stocks could expand significantly in the coming years, and billions of dollars in sales could yield significant profit. However, before you buy any marijuana stocks, it may be helpful to educate yourself a bit about the market's potential and the risks that are associated with investing in marijuana stocks.

Marijuana spills out of a medicine bottle onto a pile of money.

IMAGE SOURCE: GETTY IMAGES.

Why invest in marijuana stocks?

You may already have some reasons for wanting to invest in marijuana stocks, but as a refresher, here are some big reasons why investors are warming up to the marijuana market.

  • 8 states have approved recreational marijuana laws.
  • 28 states have approved medical marijuana laws.
  • The legal marijuana market grew 17% in 2015 to $5.4 billion, according to ArcView Market Research.
  • ArcView estimates the market grew another 25% in 2016 to $6.7 billion.
  • Since recreational marijuana laws passed in 2012, Colorado's marijuana sales are already eclipsing $1 billion per year.
  • Research into marijuana-based medicine suggests it could offer new hope to people suffering from devastating diseases, such as epilepsy.

The marijuana market is expanding quickly as states pass pro-pot legislation. But sales of marijuana could really take off now that voters have given marijuana proposals the green light in heavily populated states like California. California was at the forefront of the medical marijuana movement in the mid-90s, and as many as 1,000 medical marijuana dispensaries already operate there.

California's dispensaries will soon get much busier now that voters have OK'd the Adult Use of Marijuana Act. The Adult Use of Marijuana Act institutes a 15% excise tax on retail sales of marijuana and allows anyone of legal age to possess up to one ounce of marijuana and six marijuana plants. Businesses operating medical marijuana dispensaries will get preference for recreational marijuana licenses, and revenue that's generated from recreational marijuana taxes and fees will support the state's social programs.

California's legislation is similar to marijuana laws passed in other states, and polls suggest Americans will take advantage of these new laws. For instance, a poll conducted by the Associated Press-NORC Center for Public Affairs Research in 2016 found that 61% of Americans support legalizing marijuana. Since national support for marijuana legalization is its highest on record, it wouldn't be surprising if passing pro-pot laws cause cannabis sales to accelerate.

Beware of marijuana stock manipulators

As convincing as marijuana's market opportunity appears to be, investors need to be careful.

Currently, most marijuana stocks trade over-the-counter (OTC), and that's akin to Wall Street's Wild Wild West. Companies offering stock this way often do so because they can't meet the stringent financial and reporting requirements of major stock exchanges, including the New York Stock Exchange and the NASDAQ Exchange. As a result, OTC markets are rife with unscrupulous stock promoters attempting to separate investors from their money.

Unfortunately, many investors have already felt the sting of these pump-and-dump marijuana stock promoters. After recreational marijuana laws passed in Colorado, promoters fueled stratospheric gains in marijuana stocks. However, Securities and Exchange Commission (SEC) investigations into securities fraud have resulted in most of these marijuana stocks losing almost all their value since then.

How can you make sure that you don't fall victim to stock manipulators? The Financial Industry Regulatory Authority offers these tips:

  • Ask "Why me?" If you're hearing of a great marijuana stock out of the blue, it could be because you're the target of a paid promoter.
  • Consider the source. Be very skeptical of unknown companies that are continuously tooting their own horn. They may be trying to paint a rosier picture of their prospects than they should be.
  • Do your research. Never invest without spending a considerable amount of time considering the pros and cons.
  • Embrace auditors. SEC financial filings by companies offer a treasure trove of insight, but that insight only matters if it's been independently audited by accountants. Before buying any marijuana stock, make sure a top shelf accounting firm has signed off on the documents.
  • Avoid name changes. One marijuana company changed its name four times in ten years and another company went from selling coffee to marijuana overnight. Those examples are red flags that may signal a bad marijuana investment.
A person is rolling a marijuana joint.

IMAGE SOURCE: GETTY IMAGES.

Focus on quality

Avoiding unproven OTC stocks is a good way to reduce risk, but doing so means that investors aren't left with many marijuana stocks to consider. Among the marijuana companies that investors might want on their radar are GW Pharmaceuticals (NASDAQ:GWPH) and Insys Therapeutics (NASDAQ:INSY), two companies that are developing marijuana-based medicines.

Both GW Pharmaceuticals and Insys Therapeutics have money in the bank and research programs that hold up to scrutiny.

GW Pharma has cash and cash equivalents of $444.6 million as of December 31, 2016. That money is funding marijuana trials evaluating the ability of cannabinoids to treat various diseases, including epilepsy. Last quarter, GW Pharma spent over $30 million on research, and although a study of its THC drug Sativex failed to pan out last year in cancer pain, management has since reported results showing that epilepsy patients taking its purified CBD liquid, Epidiolex, experienced 39% fewer seizures per month than they experienced prior to treatment.

Meanwhile, Insys Therapeutics' opioid painkiller Subsys is already generating revenue at a $220 million annualized clip, but sales could head higher soon now that the FDA has OK'd Insys' reformulation of the long-standing marijuana-based medicine, Marinol. Insys Therapeutics believes its Marinol reformulation, which is being sold under the brand name Syndros, more effectively treats patients suffering from nausea caused by chemotherapy in cancer patients, as well as a lack of appetite in AIDS patients. Previously, Insys Therapeutics has said it thinks Syndros could eventually generate peak annual sales of $200 million.

A large marijuana grow facility that supplies cannabis to GW Pharmaceuticals.

IMAGE SOURCE: GW PHARMACEUTICALS, PLC

Looking ahead

Despite the opportunities ahead for these companies, they're both still very risky. GW Pharma's successful epilepsy trials suggests that it will file for FDA approval of Epidiolex this year, but there's no guarantee of an FDA approval

Insys Therapeutics isn't in the clear either. Insys' CEO stepped down over a year ago amid scrutiny tied to off-label promotion of Subsys, and more recently, former Insys executives, including its CEO, have been arrested because of illegal marketing practices. Headwinds associated with Subsys' investigations are likely to keep a lid on any optimism surrounding Syndros for a while.

Overall, there's bound to be plenty of money-losing investments in the marijuana marketplace over the coming years, and that means investors need to consider their options carefully. The risk associated with these stocks means they're best suited only for the most aggressive of investors. Other investors could be better off taking a wait-and-see approach to the industry. After all, there are plenty of other exciting investments that may be less risky to consider.

Todd Campbell has no position in any stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.