Money Morning published a piece by associate editor Cameron Saucier with the attention-catching headline “7 Reasons to Invest in Marijuana Stocks Now.” Though we represent many cannabis businesses and investors, we frequently caution against investing in the industry without knowing all the facts. It is an exciting time for the cannabis industry, but for eager investors, it is also a time of exceptional risk. Here is what you need to know before jumping on the bandwagon.
Reason No. 1 to Invest in Marijuana Stocks: Government Shift Toward Legalization
Reason No. 2 to Invest in Marijuana Stocks: Governments Will Say Yes to More Revenue
Public opinion is shifting dramatically in favor of cannabis legalization and if opinion polls told the whole story, the prospects for full cannabis legalization would look bright indeed. Unfortunately, that is not necessarily the case. Even as more and more states consider legalization, Congress rejected moves to increase access to medical marijuana for veterans and ease restrictions on medical marijuana research in the last two months alone. Recent reports also suggest the DEA might not follow-through with its rumored rescheduling of cannabis under the Controlled Substances Act after all. And even if it does, opinions on whether that would benefit the industry range from predictions that it would not change much to that it would be the “nightmare scenario” for state markets. Though we do not agree with the latter characterization, one thing is clear: rescheduling is a poor substitute for federal legislative reform.
Saucier rightly points out that governments are eager to collect the hundreds of millions of dollars in tax revenue generated by the cannabis industry. This can be a double-edged sword, however – after all, they really do want that money. According to a 2015 survey, cannabis businesses are more than three times as likely to be audited by the IRS than other businesses. An audit – even if successful – is expensive, time consuming, and can scare away new investors. The issue is compounded by Section 280E of the Internal Revenue Code, which prohibits many standard business deductions for companies trafficking federally controlled substances. Uncertainty as to its scope can attract unwanted attention from the IRS, and its proper application can greatly impact cannabis entrepreneurs’ bottom line. Many cannabis businesses pay an effective tax rate of as much as 70%, a major limit on profitability and the ability to reinvest revenues to fuel growth. 280E will continue to be a hindrance to cannabis business absent federal reform.
Reason No. 3 to Invest in Marijuana Stocks: It’s the Fastest-Growing Industry
It is true: cannabis is among the fastest-growing industries in the United States. But, fast growth is not always sustainable – especially given the sheer quantity of variables facing the cannabis industry. One need only to recall the dot-com bubble of the late 1990s and early 2000s to appreciate just how quickly the “sure thing” of rapid growth can collapse. For a more recent example, social commerce start-up Groupon has sputtered over the last several years after once being the fastest growing company in history. Now far from its heyday, founder and former CEO Andrew Mason has been named one of the “14 Most Spectacular Failures” of Silicon Valley by Vanity Fair and Groupon stock has lost over 80% of its value since 2012. Though Groupon inspired numerous competitors, some of which have found success, early investors in Groupon are likely feeling they bet on the wrong horse. Early cannabis investors should beware falling into a similar trap; the companies that dominate today may not even be here tomorrow.
Reason No. 4 to Invest in Marijuana Stocks: Widespread Medical Use
Medical marijuana has been around for twenty years now, and it is still trending up. Nonetheless, investments in medical applications of cannabis are far from guaranteed. Game-changing innovations in medicinal cannabis will require both the end of federal prohibition and approval from the FDA. Obtaining FDA approval is an arduous process that costs millions of dollars and can take years of reviews and clinical trials; even after that, only 8% of drugs are approved. Though the medical properties of cannabis are promising, it is still a risky and long-term investment.
Reason No. 5 to Invest in Marijuana Stocks: The Growth in Investment Options
The diversification of investment options in the cannabis industry is certainly good news for investors, but it is not necessarily good for cannabis stocks. The stocks touted in Saucier’s piece are penny stocks, which are notoriously risky. Lack of publicly available information, transparency, company track record, and liquidity are all reasons why penny stocks – cannabis or otherwise – are typically not the best option for most investors. Of course, there may be exceptions to this rule, but we generally advise great caution before investing in publicly traded cannabis stocks.
Reason No. 6 to Invest in Marijuana Stocks: Banks Will Service the Business
Saucier makes reference to an amendment to a June spending bill that would have precluded federally appropriated funds from being used to penalize banks that service the cannabis industry. Unfortunately, that amendment was rejected by the House of Representatives. This failure means that lack of access to banking will remain a significant impediment to cannabis businesses as we have writtenaboutextensively. It also demonstrates why a softening stance towards the cannabis industry by the federal government should never be taken for granted. Even in those states with good banking access for cannabis businesses, those banks that take on cannabis customers typically charge them high rates to make up for an increased regulatory and oversight burden.
Reason No. 7 to Invest in Marijuana Stocks: The Rise of Subsectors
Saucier rightly points out that many industries stand to benefit from relaxed regulation of cannabis, such as biotechnology and software development. Cannabis businesses in these sectors ultimately depend on the continued trend towards legalization, however, and cannot completely insulate themselves from a potential federal crackdown or reversal of state-level gains. Similarly, cannabis businesses in these sectors cannot fully insulate themselves from volatility in non-cannabis portions of these sectors. Investors may be better off sticking to traditional blue-chip companies in these sectors for the time being; after all, they may be the first in line to acquire successful niche cannabis businesses if “Big Canna” ever becomes a reality.
In sum, there are many reasons to be optimistic about the future of cannabis legalization and investors can – and are – making money in the industry. Nonetheless, would-be investors should fully appraise the risks and beware that any industry or company that sounds too good to be true usually is.
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