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The 4-Letter Word Cannabis Investors Need to Know

Sean Williams, The Motley Fool

Over the next decade, the global marijuana industry is expected to deliver once-in-a-generation-type growth potential. Following a year that saw worldwide licensed-store sales climb to $10.9 billion, projections from Arcview Market Research and BDS Analytics suggest that global weed sales could top $40 billion by 2024, with most investment banks on Wall Street looking for anywhere from $50 billion to $200 billion in annual sales by 2029 or 2030.

This forecasted surge in legal marijuana sales is why Wall Street and investors have been piling into cannabis stocks since the beginning of 2016. Even following four very rough months for pot stocks since the beginning of April, the industry's biggest names have risen by a quadruple-digit percentage in less than four years.

A gloved processor with scissors trimming a cannabis flower.

Image source: Getty Images.

The four-letter word pot stock investors need to know

But success as a cannabis stock investor is far from a given. That brings me to my main point about investing in marijuana stocks -- namely, that there's a four-letter word you're going to have to acquaint yourself with if you have any shot of succeeding as an investor in the cannabis space. And, no, it's not a swear word, although I could fully understand how the recent downtrend in pot stocks could trigger those sorts of emotions with certain investors.

If you want to be successful as a cannabis investor, the four-letter word you need to become familiar with is "time."

The marijuana industry is what I, personally, like to classify as a "next-big-thing investment." Sure, cannabis isn't exactly innovative, given the fact that it's a plant that's been around for a long time. But it does have next-big-thing growth potential, as described by its potential ascent from $10.9 billion in global worldwide sales to as much as $200 billion in a decade's time. You'd struggle to find a growth rate that high in other sectors and industries.

But the thing about next-big-thing investments is that investor expectations have, historically, always outrun the actual growth trajectories of these investments. Whether we're talking about the rise of the internet, business-to-business commerce, decoding the human genome, 3D printing, blockchain technology, or a host of other perceived-to-be game-changing investment opportunities, the expectations of Wall Street and investors easily outpaced the actual growth of these industries, at least in their early stages.

Another way to rephrase everything I've said here is this: The marijuana industry will need time to mature.

A businessman holding a stopwatch behind an ascending stack of gold coins.

Image source: Getty Images.

The cannabis industry is a work-in-progress

Expecting pot stocks to come roaring out of the gate from a sales and profit perspective is simply unrealistic. Let's remember that no developed country in the world had ever legalized recreational weed before Canada, and the U.S. federal government remains opposed to legalization. That leaves our neighbor to the north as a sort of guinea pig for the rest of the world, and it makes things very complicated in the U.S., with each legalized state -- and even municipalities within legalized states -- having varying laws concerning medical and/or recreational pot.

Canada, for example, has been contending with a persistent shortage of cannabis since recreational sales of the drug began on Oct. 17, 2018. A good chunk of the blame for this shortage has been placed on a mountain-high backlog of licensing applications that Health Canada has on its plate for review. These licensing applications often take months to more than a year to review, which has slowed the pace of cultivation, processing, distribution, and sales in the country.

In addition, Canada is also contending with compliant packaging solution shortages and a slow dispensary licensing approval process in select provinces, and the growers themselves are, in many instances, still completing the build-out of their production capacity.

Meanwhile, in the U.S., much of the blame for tempered sales results (ahem, California) rests with high tax rates on legalized cannabis. The aggregate tax rate on legal California weed tops 40% in most cities, which has spurred black-market producers who don't pay these taxes or abide by the same licensing wait times that legal businesses do. Since illicit growers can drastically undercut the legal market on price, California became the first state to see a decline in legal pot revenue in 2018.

None of these issues is necessarily a long-term problem for the legal marijuana industry, but it does demonstrate that the cannabis industry is a work-in-progress.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

It's time to temper your near-term expectations

Take the most popular marijuana stock in the world, Aurora Cannabis (NYSE: ACB), as the perfect relatable example.

On one hand, Aurora Cannabis is the projected leading producer in Canada, with perhaps as much as 700,000 kilos per year when fully operational, and it has a superior global presence, relative to its peers. Including Canada, Aurora has a presence in 25 countries, with the expectation being that these external sales channels will come in handy just as oversupply and commoditization hits the recreational Canadian marketplace. On paper, it looks like the company can't be stopped, especially with a rapid sales growth trajectory.

But looks can be deceiving in an industry that needs time to mature. While I don't disagree with Aurora's fundamental strategy, I'd point out that it requires demand in Canada to be satisfied first before external channel sales really pick up. Given the noted supply issues throughout much of the country, it could be years before Aurora really begins to see the fruits of its international expansion pay off. That likely makes Wall Street's sales and profit projections in the near term for Aurora Cannabis too aggressive.

The same could be said for cash-rich Cronos Group (NASDAQ: CRON). After receiving a $1.8 billion equity investment from Altria, Cronos aims to turn itself into a cannabinoid giant. It'll lean on Altria's knowledge to produce a superior line of vape products in Canada, and it has worked out an agreement with Ginkgo Bioworks worth up to $100 million to produce targeted cannabinoids at commercial scale. Since derivative products like these carry superior margins to traditional dried cannabis flower, Cronos Group would appear to have everything investors are looking for in a pot stock.

Yet, Cronos Group is likely going to be subjected to the same supply issues that the Canadian dried flower market has contended with. Even with Health Canada and packaging suppliers implementing solutions that are designed to get more legal product in licensed dispensaries, Canada's supply chain isn't going to be fixed overnight. That threatens Cronos Group's near-term chances of operating profitability, sans one-time benefits.

In order to succeed as a cannabis investor, you're going to have to be patient and allow for the proper amount of time to pass for the industry, and these businesses, to mature. Invest for the future, not the present.


Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com