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The Single Biggest Reason to Stay Away From Canadian Marijuana Stocks

Keith Speights, The Motley Fool

Some investors have profited from a version of "reefer madness" over the past year. The stocks of Canadian marijuana growers have skyrocketed. Canopy Growth Corporation's (NYSE: CGC) share price has nearly quintupled over the past 12 months. So has the stock price for Cronos Group (NASDAQ: CRON). Aurora Cannabis (NASDAQOTH: ACBFF) stock has quadrupled. Aphria's (NASDAQOTH: APHQF) share price more than doubled during the period.

The anticipation of Canada's legalization of recreational marijuana has, of course, played a major role in driving these stocks higher. With the country set to open up the recreational market in October, some investors might be champing at the bit to jump aboard the train and scoop up shares of Canadian marijuana growers.

But before you take the leap, you need to know about the single biggest reason why you might want to stay away from Canadian marijuana stocks.

Marijuana leaves forming an X against a black background

Image source: Getty Images.

It's not about Canada

Let's first address what isn't the primary reason to avoid buying Canadian marijuana stocks. It's not that the country is heading for a massive supply glut of cannabis.

Am I saying that supply won't outstrip demand in the near future? Not at all. I think that's exactly what will happen. It doesn't take a genius to compare the annual production capacity that the top growers are projecting against estimates for Canadian demand for cannabis to know that a glut is coming.

I don't think, though, that the inevitable supply glut in Canada is the top reason to stay away from Canadian marijuana stocks. Why? The executives of the biggest marijuana growers in the country know what's in store and aren't too concerned about it.

Aphria CEO Vic Neufield, for example, predicts that supply will catch up with and surpass demand, with the result that marijuana growers will be forced to cut prices. He thinks this will create an opportunity for consolidation in the industry. But Neufield believes that Aphria will be in good shape when that happens.

Aurora Cannabis Chief Corporate Officer Cam Battley stated last month that his company isn't worried about a supply glut. He is skeptical of the capacity projections for some marijuana growers. More importantly, Aurora, like several of its large peers, is eyeing a much larger opportunity.

Worldwide weed or worldwide wait?

This bigger opportunity lies outside Canada. The major marijuana growers in Canada have already staked a claim in the German medical cannabis market. They're also expanding into Australia. Canopy Growth recently acquired a small company in Lesotho to position an entrance into South Africa if the country legalizes medical marijuana. Aurora Cannabis also has South Africa on its radar. 

Cam Battley thinks the global marijuana market could be "enormous" -- potentially as big as $180 billion annually. That estimate, however, includes several countries that haven't legalized marijuana yet. But even if you only count nations that have legalized cannabis in some form, the potential demand could be well above the projected annual capacity of top Canadian marijuana growers.

This "worldwide weed" scenario could even make Canadian marijuana stocks' sky-high current valuations seem much less scary. Why worry about Aurora's market cap of nearly $4 billion and Canopy Growth's market cap of close to $6 billion when the global market could be greater than $100 billion?

Marijuana leaves in front of a globe

Image source: Getty Images.

Before you log into your online trading account to start buying marijuana stocks, though, you need to consider another perspective. I spoke recently with BDS Analytics CEO Roy Bingham about the state of the global cannabis industry. Bingham is a former McKinsey consultant who, along with his team at BDS Analytics, takes the analysis of the industry quite seriously. He is optimistic that the global marijuana market could top $100 billion. However, Bingham doesn't expect it to reach that level quickly.

In the sixth edition of The State of Legal Marijuana Markets, published recently by ArcView Research and BDS Analytics, the worldwide legal marijuana market is projected to be around $32 billion in 2022. Roughly 73% of total global marijuana sales are expected to be generated in the U.S., with less than 10% of the total coming from countries outside North America.

Right now, the big Canadian marijuana growers are staying away from the U.S. market. They face the threat of being delisted from the Toronto Stock Exchange by having significant U.S. operations while U.S. federal laws prohibit the sale of marijuana.

But if the U.S. market is excluded, the global opportunity is pretty small over the next several years if the ArcView Research/BDS Analytics projections are relatively accurate. Because of this, my view is that the single biggest reason to not buy Canadian marijuana stocks is that the "worldwide weed" opportunity could be more of a "worldwide wait."

Caution needed

There are other avenues for growth available to marijuana growers. Canopy Growth CEO Bruce Linton acknowledged in a CNBC interview a few weeks ago that "by 2020 or 2021, there will be too much cannabis produced" in Canada. However, Linton didn't try to tie Canopy's fortunes only to the global medical marijuana market. He pointed to opportunities for marijuana-based products such as cannabis-infused beverages and cannabis-based sleep aids. 

It's possible that Canadian marijuana growers like Canopy Growth will be able to expand into new ancillary markets. It's also possible that the global marijuana market size will increase faster than ArcView Research and BDS Analytics think it will. 

I wouldn't say that there's necessarily a red light for buying Canadian marijuana stocks. However, I do think the light is yellow instead of green. Investors looking at Canadian marijuana stocks should exercise caution.

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Keith Speights 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.