Everything You Need to Know — The Motley Fool

The opening of Canada’s recreational, adult-use marijuana market in October 2018 improved the odds that marijuana will become legal in other developed nations. Worldwide, the United Nations estimates that $150 billion is spent on marijuana every year, so legalization represents a massive market opportunity for cannabis growers, processors, and retailers. Are you prepared to profit from pot? Read on to discover whether investing in the marijuana industry is the right move for you.

A powerful plant

Cannabis has a long history of industrial, recreational, and medicinal use. In China, a variety of cannabis called hemp was used to make rope as far back as 10,000 B.C., and hemp has also been used to make sails, paper, and clothing for thousands of years. In fact, industrial hemp was so important to colonial economies that settlers arrived in America with hemp seeds in hand, and the English crown demanded every farmer set aside some land to farm it.

A purified form of cannabis called hashish has been smoked in the Middle East since at least 800 A.D., and it has a long history of consumption in India, where it is referred to in ancient texts. Bhang, a marijuana beverage, was a staple for Sikh warriors before battle, and bhang is still commonly consumed in India today.

Marijuana’s medical uses are also well documented. Cannabis contains more than 100 chemicals called cannabinoids, all of which can interact with humans’ natural endocannabinoid system. This natural biological system helps our bodies manage physiological and cognitive functions, including appetite, pain, and mood.

There are two primary endocannabinoid receptors: CB1 and CB2. CB1 receptors are mostly located in the central nervous system, while CB2 receptors are mostly found in the immune system. The interaction of tetrahydrocannabinol (THC, the most common chemical cannabinoid) with CB1 is what causes marijuana’s high, while the direct and indirect interaction of cannabidiol (CBD, the second-most-common cannabinoid) with CB1 and CB2 offers medicinal benefits, including effectively reducing seizures in epilepsy patients.

How marijuana became illegal

Following a widespread opium epidemic in the 1800s and early 1900s, Americans grew increasingly concerned about mind-altering drugs.

It began with doctors who frequently prescribed opium for pain relief in soldiers returning from the Civil War. The situation accelerated amid immigration from China, where recreational use of opium was common. “Dens” in various U.S. cities facilitated the use of the drug for its mind-altering effects, and a national crisis emerged. By 1895, 1 in 200 Americans was affected in one way or another by opiate addiction, and by 1900, the use of opium and morphine, another potent opiate, had reached epidemic proportions in America. This brought about federal laws designed to reduce opiate use in 1909, and in 1914, the Harrison Narcotic Act outlawed recreational use altogether.

Around the same time, concern about the negative effects associated with widespread alcohol consumption was mounting. In 1918, Congress passed the Wartime Prohibition Act, banning beverages with an alcohol content higher than 1.28%, and in 1919, it passed the 18th Amendment to the U.S. Constitution, prohibiting alcohol outright.

Given the attitudes of the time, it’s unsurprising that marijuana also came under scrutiny. The use of marijuana as medicine had increased in the U.S. throughout the 1800s, particularly for gastrointestinal problems. Recreational use also expanded markedly because of immigration from Mexico, where use of the drug for pleasure was more common. Individual states, worried that increasing marijuana use would lead to an opiate- or alcohol-like epidemic, passed anti-marijuana laws in the 1920s and 1930s; when the Marijuana Tax Act was passed in 1937, marijuana became illegal nationwide.

Cannabis came under increased scrutiny in 1961, when most of the developed world signed a treaty called the Single Convention on Narcotic Drugs. That was followed in 1970 by the U.S. Controlled Substances Act, which classified marijuana as a Schedule I controlled substance, creating the modern era of marijuana prohibition.

Marijuana legalization efforts

Despite laws and treaties prohibiting marijuana use, momentum has been steadily increasing for worldwide legalization. Initially, much of this push was for medicinal marijuana use, but a groundswell of support has emerged for adult recreational use as well.

In 1996, California became the first U.S. state to pass laws allowing the medical use of marijuana. Since then, 33 states have followed suit, and all but three of the 50 U.S. states have legalized CBD. In 2012, Colorado and Washington State became the first to pass laws creating adult-use markets for recreational marijuana, and as of February 2019, seven others have followed (including California, where a statewide recreational market opened in January 2018).

Despite steps to break down barriers to marijuana access in individual states, the substance remains illegal at the federal level. Under President Obama, the Department of Justice directed federal attorneys not to prosecute most federal marijuana crimes in states with recreational pro-pot laws. However, federal laws still hamstring the market by limiting access to banking services and eliminating many tax deductions for industry participants.

In Canada, the situation is different. Canada’s national medical marijuana market has flourished since a licensing system was put in place in 2014. In 2018, Canada became the first of the G8 developed nations to open a national adult-use market for marijuana, too.

There’s also growing momentum to legalize marijuana in Germany, where a national medical marijuana market was created in 2017. Other large European Union countries also appear ready to open the door to medical marijuana. For instance, Canadian cannabis companies have begun shipping medical marijuana to the United Kingdom following a 2018 decision that allows limited use there. Elsewhere, 14 sovereign countries have passed pro-medical marijuana laws as of February 2019, including Australia.

A marijuana industry primer

All that said, most marijuana sales still take place on the black market. Of the $150 billion-plus per year the United Nations estimates is spent on marijuana, only a small portion is pocketed by companies operating legally. For perspective, Statistics Canada estimates Canadians spent $6 billion in Canadian dollars on marijuana in 2018, but legal sales for medical use were only in the hundreds of millions, and recreational markets were only open for two months that year.

The situation is similar in the U.S., where the marijuana market is worth $50 billion annually. Legal recreational sales were just $8.4 billion in 2018, and medical sales were only $4 billion, according to Matt Karnes of GreenWave Advisors.

That said, more and more marijuana sales are shifting to legal markets, and that makes it important to understand the industries that are benefiting from this trend — including growers, processors, retailers, suppliers, and drug makers.

Marijuana growers

Cannabis farming is big business, and it’s likely to get bigger since the passage of the U.S. Farm Bill in 2018. That bill removed hemp from the controlled substances list, clearing the way for cannabis companies to grow more hemp indoors, in greenhouses, and on farms in America. The cheapest way to cultivate cannabis is outdoors, but it’s more difficult to maximize yield and maintain quality outside. Indoor facilities provide the best environment for cultivation, but they’re more expensive than greenhouses to operate, so most growers are embracing greenhouses instead.

Marijuana processors

Dried marijuana flower accounts for a lot of marijuana market sales, but companies are also increasingly processing cannabis to extract its chemical cannabinoids into value-added products such as oils. These cannabis-derived concentrates can be sold to consumers at a higher price per gram than dried flower, or they can be used as ingredients to produce other products, such as food and beverages.

Marijuana retailers

In some jurisdictions, consumers can buy marijuana from online stores, but mostly, it’s purchased at physical stores called dispensaries.

Marijuana industry suppliers

Growing marijuana indoors requires specialized equipment; extracting cannabinoids from marijuana requires chemicals; and marijuana packaging is regulated by governments to prevent underage use. Therefore, specialized suppliers are seeing demand increase because of marijuana legalization, too.

Marijuana drug makers

It used to be very hard for scientists to acquire adequate amounts of research-grade marijuana for clinical studies. These obstacles are disappearing, prompting companies to start more studies evaluating marijuana’s safety and efficacy as medicine. If successful, these trials could support Food and Drug Administration (FDA) approval of new cannabis drugs, sidestepping marijuana prohibition in places where it remains illegal while providing a patent-protected revenue stream.

Ways to invest in marijuana

If you’re interested in profiting from pot, you can consider exchange-traded funds (ETF) or individual stocks.

ETFs pool together money from many investors so that they can own many stocks. Therefore, ETFs provide a simple way to gain broad exposure to pot stocks. However, ETFs do have drawbacks. Marijuana ETFs must be bought through a broker, so you’ll pay a commission each time you buy or sell. Also, you’ll pay annual fees (usually expressed as a percentage of assets) to the company managing the ETF. Furthermore, ETFs can buy or sell stocks more frequently than you might want, causing unexpected capital-gains taxes.

ETFs give you more diversification, but individual stocks allow you to invest in the companies in which you have the most interest. If you hold your stocks for longer than one year, buying individual stocks can limit your capital gains taxes, too. And you won’t pay a management fee if you buy individual stocks on your own. But you’ll still pay commissions when you buy or sell individual stocks, and the risk can be great if you invest in a stock that drops.

Investors should also know that most cannabis stocks don’t trade on the major U.S. stock exchanges. Marijuana companies listed on major exchanges can’t do business where it’s illegal at the federal level, so cannabis companies are either avoiding the U.S. market or choosing to hold off on listing their shares on the New York Stock Exchange or Nasdaq.

As a result, the company you might want to buy could be listed on the less regulated over-the-counter (OTC) market, or it might be available on a foreign exchange, such as the Toronto Stock Exchange. OTC stocks aren’t subject to the same strict financial requirements as stocks listed on major exchanges, though. And OTC stock prices can be volatile because of limited trading volume and narrow price transparency. You may have to get special permissions from your brokerage to buy foreign stocks, and trading them means accepting currency-exchange risks that can take a bite out of your profit.

That said, this drawback may become less of a problem for individual stock investors in the future. A handful of companies targeting the marijuana market outside the U.S. listed their shares on the NYSE or Nasdaq in 2018, and more companies could follow suit — especially if they focus on hemp, which is no longer a schedule I substance in America.

Marijuana growers: Stocks to buy

Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB) are the two biggest global marijuana companies, and fortunately, shares of both companies now trade on the New York Stock Exchange.

Canopy Growth hasn’t said exactly how much marijuana it plans to produce in the future, but its annualized quarterly sales finished 2018 at a pace of more than CA$300 million. Aurora Cannabis says it’s targeting production of more than 500,000 kilograms of marijuana per year; in 2018, its revenue was CA$121 million.

Most of these companies’ revenue has historically come from Canada’s medical marijuana market. Canopy Growth estimates its medical marijuana market share at higher than 30%, and while Aurora Cannabis is smaller, it had still served 73,579 active registered patients as of the end of December 2018.

In the future, both companies will likely generate an increasing amount of their revenue from Canada’s adult-use recreational market, though. Recreational sales in the Great White North began on Oct. 17, 2018, and as that market matures, it could represent a multibillion-dollar opportunity. According to Deloitte, Canada’s recreational sales could total between CA$1.8 billion and CA$4.3 billion in 2019. (By comparison, Deloitte thinks medical marijuana sales there will be between CA$770 million and CA$1.79 billion for the same period.)

Investors interested in these two growers should know that only one of them has won an investment from a major U.S. business. In 2018, beer, wine, and spirits company Constellation Brands (NYSE:STZ) acquired a 38% stake in Canopy Growth for roughly $4 billion. The investment arguably gives Canopy Growth an edge over Aurora Cannabis by providing financial flexibility Canopy could use to enter new markets, as well as marketing, distribution, and regulatory experience it can leverage to avoid mishaps. In January 2019, Canopy’s management announced that they will spend up to $150 million of this windfall on an innovative “Hemp Industrial Park” in New York state, making this the first Canadian grower with plans to enter the United States following the passage of the U.S. Farm Bill.

Although Aurora Cannabis hasn’t taken on a big investor yet, it’s arguably been the most aggressive acquirer of cannabis companies, and there’s always the chance that a suitor will emerge. In 2018, Aurora’s acquisitions included major medical marijuana companies CannaMed and MedReleaf, making its product lineup one of the most attractive in the industry. As of Dec. 31, 2018, Aurora Cannabis’s recreational market share was 20%, while Canopy Growth’s market share could have been north of 50%, based on Aurora’s figures. As a result, these are the top two growers that ought to be on every investor’s radar.

Marijuana suppliers: Stocks to buy

There are other marijuana company suppliers, but Scotts Miracle-Gro (NYSE:SMG) and KushCo Holdings (NASDAQOTH:KSHB) are the two largest publicly traded ones investors can buy.

Scotts Miracle-Gro is best known for its plant-nutrient and weed-control products, but it has aggressively been acquiring hydroponics and lighting companies to position itself as one of the marijuana industry’s biggest vendors. The company is consolidating these deals under its Hawthorne banner. Hawthorne exited 2018 with quarterly sales of $140.8 million, up 84% year over year, largely because of its $450 million acquisition of major hydroponics vendor Sunlight Supply in 2018.

Sunlight Supply added $460 million in 2017 sales to Hawthorne’s $290 million, so it was a game-changing acquisition for Scotts Miracle-Gro. That said, the hydroponics business hasn’t been without stumbles. It enjoyed rapid growth in places like Colorado following legalization, but demand tapered off in 2018 as oversupply in mature markets caused a drop in wholesale marijuana prices. That slowdown in demand is likely to be temporary, however. Tailwinds tied to changes in hemp regulations and the legalization of marijuana in more states could help sales growth rebound in 2019.

Unlike Scotts Miracle-Gro, KushCo Holdings is focusing on marijuana packaging and processing. The company provides specialized packaging, such as tamper-resistant bottles, that comply with strict regulations in legal marijuana markets. It’s the biggest of the packaging companies, and its sales surged in 2018 thanks to the opening of California’s adult-use market, growing demand in Canada, and new facilities serving new markets on the East Coast (including Massachusetts). Sales rose by 177% to $52 million in fiscal 2018, and that number is expected to exceed $110 million in fiscal 2019. In addition to packaging, KushCo’s Kush Energy division also sells solvents used to produce marijuana concentrates.

Marijuana dispensaries: Stocks to buy

The marijuana retail market consists of e-commerce storefronts and traditional dispensaries. One of the best ways to profit from growing online sales is to invest in leading e-commerce platform Shopify (NYSE:SHOP). The dispensary market is highly fragmented, with many small players, but Curaleaf Holdings (NASDAQOTH:CURLF) and MedMen (NASDAQOTH:MMNFF) have a chance to be two of the biggest retailers in America.

Companies from every industry use Shopify’s internet software solutions to manage their online and physical store footprints. The company has secured deals to be the backbone behind e-commerce for cannabis in key Canadian provinces, including Ontario, Canada’s largest market. It’s also won contracts with vertically integrated companies operating dispensaries in Canada. Its success in landing deals to help growers, processors, and distributors comply with regulations and enforcement provides it with a platform it can leverage in the future to serve additional markets that legalize marijuana.

This is far from a marijuana pure play, though. Shopify’s sales totaled $1.07 billion in 2018, up 59% over 2017; the company didn’t break out how much cannabis contributed to that figure, but we can assume it wasn’t a significant driver of performance. Nevertheless, Shopify is a big, fast-growing company that’s turning a profit, and future cannabis revenue only makes it a more attractive growth stock to consider buying.

As for Curaleaf, the company was operating 42 dispensaries in the U.S. as of January 2019, as well as processing marijuana from 12 cultivation sites at 10 facilities in 13 states. Curaleaf hopes to have 69 dispensaries open by the end of this year. Most of its sales (98% as of the end of 2018) come from selling medical marijuana products under its own private-label brand, but as recreational laws are passed in states with existing medical-marijuana dispensaries, its revenue mix is likely to shift.

Curaleaf is primarily an East Coast operator. In terms of store count, Florida is its biggest state, with 22 locations as of February 2019 and plans for 13 more before the end of the year. Nationwide, management plans to open about one new store per week in 2019. It also has the opportunity to grow through acquisitions; its October 2018 IPO added more than $400 million to its balance sheet.

MedMen has big aspirations, too. The company operates 20 dispensaries in five states, including nine stores in California. Those California stores accounted for 90% of revenue in 2018, but a deal to acquire medical marijuana grower PharmaCann will diversify it across more states. If the deal goes off without a hitch, it will increase MedMen’s store count to 30 dispensaries, with an opportunity to open up to 78 stores across 12 states. That said, between MedMen and Curaleaf, MedMen may be riskier because it doesn’t have as much cash in the bank. At the end of fiscal 2018, MedMen’s cash stockpile was $79 million.

Marijuana pharmaceuticals: Stocks to buy

If you’re interested in investing in marijuana drugmakers, you could invest in growers that are conducting clinical trials, including Canopy Growth. But if you want to invest in a company with an FDA-approved CBD drug on the market in the United States, GW Pharmaceuticals (NASDAQ:GWPH) is your only option.

GW Pharmaceuticals is a UK-based drug developer that has been studying the safety and effectiveness of marijuana’s cannabinoids since the 1990s. It has marketed the THC drug Sativex, which treats muscle spasticity in multiple sclerosis, in the European Union for years, but the company only recently launched its first drug, Epidiolex, in America.

Epidiolex is a purified CBD oil that secured an FDA green light in 2018 following human trials showing it reduces seizures in patients with two treatment-resistant forms of epilepsy: Dravet syndrome and Lennox-Gastaut syndrome. These forms of epilepsy can be debilitating, and existing anti-epileptic medications have historically proven inadequate in controlling them. In its trials, Epidiolex reduced the number of monthly seizures patients were experiencing by 40% to 50%. Its effectiveness won it an OK from the FDA in June 2018, and it officially became available in November after the Drug Enforcement Agency classified it as a Schedule V drug. The least stringent classification in the schedule, Schedule V also includes cough syrup containing codeine.

Dravet syndrome and Lennox-Gastaut syndrome are rare, affecting roughly 70,000 people, but if Epidiolex can make its way into wider usage, its commercial opportunity could be significant. GW Pharmaceuticals has priced it at $32,500 per year and expects insurers to cover it widely. Approximately one-third of the 3.4 million people in the U.S. with epilepsy don’t adequately respond to other treatment alternatives.

Don’t ignore the risks 

Despite the size of the opportunity associated with legalizing $150 billion in global marijuana sales, marijuana investing isn’t for the faint of heart. The industry is only now emerging, and many of the companies angling for market share today may wind up falling shy of sky-high predictions — or, worse, going bankrupt. Nevertheless, the potential here is significant enough to warrant investors’ attention. Just make sure you’re willing to do your homework. You want to thoroughly understand the industry and the companies you’re interested in owning before you buy.