Is It a Good Idea to Invest in Marijuana Stocks?

Throughout the developed world, countries are starting to loosen their stances on cannabis. In Canada, for example, cannabis is now legal for both medicinal and recreational purposes. Accordingly, companies have started springing up to take advantage of the new market, focusing on growing, cultivating, distribution, or some other phase of the process; you can even buy cannabis online thanks to businesses like Bud Buddies.

In the United States, the momentum seems to be headed in this direction. There are 10 states that have fully legalized marijuana, while the majority of other states have decriminalized it and/or allowed it for medicinal purposes. Along multiple links in the cannabis supply chain, we’re seeing the rise of new startups. These companies often go public in an attempt to raise funds for their new operations, giving rise to the moniker “marijuana stocks.” So is it a good idea to invest in these up-and-coming companies, which are hoping to take over a new industry?

The Allure of Marijuana Stocks

The allure and advantages of marijuana stocks are apparent even to someone with minimal investing experience. Cannabis has been illegal, and therefore an off-limits area of business development, for a century—yet there’s clearly already a strong market for marijuana, and that market might grow further when the drug inevitably becomes legalized. Investing in a marijuana company now is akin to getting in at the ground floor; you’ll be investing in the company’s earliest days, when it’s extremely cheap to do so. If the company expands to a national level and dominates their area of specialty, it could hypothetically make you rich.

It’s estimated that the global market for marijuana will more than triple from 2018 to 2022, and much of that growth could be concentrated in the United States. If this estimation proves to be true, there will undeniably be some big winners; several marijuana stocks will make enormous jumps, ultimately returning investments many, many times over.

The Complicating Factors

That may all sound good, but there are several complicating factors that throw a wrench in this picturesque vision of marijuana stock investment:

1. The path to legalization. There’s no guarantee that the United States is going to legalize marijuana entirely, or that this will happen in the next few years. It seems that momentum is heading this way, but the path to legalization is extremely complex, regardless.
2. The supply chain. Marijuana growth and distribution are complex industries, and there are companies specializing in every phase of the process. Unless you’re very familiar with how this process works, and what would make for a “good” company in each of these areas, it’s unlikely you’ll be able to make an accurate assessment of which area provides the best investment opportunity.
3. Black market dealers. Marijuana revenues in California didn’t climb as fast as projections foretold. Many estimate this is because of black market dealers, who are able to sell marijuana at much lower prices than official dispensaries, and face fewer risks for the transactions. With legal marijuana prices so high, this will likely have a crippling effect on industry growth for some time.
4. Picking a winner. Assuming the cannabis industry takes off, only a handful of the hundreds of startups that arise are going to win big in the long term. Are you confident in your ability to pick a winner? It’s much more difficult than it seems.
5. Built-in pricing. This is probably the most significant factor to consider, because it affects all marijuana stocks and will inevitably affect your potential return. Remember earlier in this article, we mentioned that the upside of marijuana stocks is “apparent even to someone with minimal investing experience.” In other words, everyone knows that marijuana stocks could be a massive growth market. Accordingly, the future growth potential of a stock is already built into the price. Because so many people are hoping to get rich from investing in marijuana stocks, they’re buying such stocks in enormous volumes, pushing prices higher. If and when those companies start to expand and do well, they’ll be meeting investor expectations—not exceeding them. Accordingly, their prices won’t stand to grow as quickly as their revenues or bases of operation. Most big winners in the stock market come from deviating from broad market expectations, not simply complying with them.
6. Market volatility. Cannabis is going to be a brand-new industry, and therefore one that’s somewhat unpredictable. There are likely going to be big ups and big downs as investors collectively figure out the appropriate ways to react to news.

So should you invest in marijuana stocks? They could be a valuable opportunity, but only if you truly understand the business model and the risks involved. Investing in the industry blindly is only going to result in disappointment.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.