Cannabis is a once-in-a-generation investment opportunity. The chance to invest in an industry in its infancy with so much growth in its future is rare and shouldn't be missed. There are other high-growth industries, but as described below, cannabis offers a constellation of drivers that sets its potential apart. There are challenges, however, and individual investor success is by no means inevitable. The rising tide of cannabis industry growth will not lift all boats, particularly those with big holes in them. This article will spotlight the challenges in an industry best-described as chaotic and propose an investment approach that maximizes the probability of success.
Note: In this article, cannabis refers to all marijuana-related businesses, purveyors of both THC and CBD. It is focused on the United States and Canada, the largest and most accessible market for most readers.
Projections for the size of the cannabis market are mind-boggling. Statistics vary considerably, but for recreational use alone, Morningstar calculates a 25% annual sales growth rate from the current $5.4 billion to $68 billion by 2030.
The well-respected Medical Marijuana Inc. provides the following enticing projections:
$820 million (2017)
$1.9 billion (2022)
There are a number of compelling forces driving the cannabis industry forward:
“Sin” businesses are historically very successful and durable over long periods. People have an insatiable drive to seek out things that give pleasure and are addictive to some degree. This pretty well defines marijuana, along with tobacco, alcohol, and gambling. In addition, evidence of the therapeutic benefits of CBD for various conditions is mounting. CBD addresses humans' perpetual drive to search out and consume anything that may make them better, and if just some of the claims for the benefits of CBD are valid, its success is guaranteed.
There is a sea change in society that is making cannabis acceptable. Momentum continues to increase across the country. There is little organized opposition, and it's difficult to imagine anything reversing the momentum. Recreational marijuana is now legal in 11 states, medical in 33 states, CBD in 50 states.
Governments everywhere are eager to tap this new and potentially very large source of revenue. This makes the government a powerful ally and a force for encouraging more access for more people. It brings to mind gambling. Once upon a time, the government viewed gambling as evil; now, there are lotteries in 44 states.
The industry consists almost entirely of small pure-plays. Investment dollars are 100% in cannabis. There is no large corporation that can dominate and impoverish competitors.
The potential is intoxicating, but the dangers of cannabis investing must not be underestimated. Statistics vary, but around 50% of new ventures fail in the first two years, and in spite of the hype, cannabis will be no different. Critical issues in evaluating cannabis ventures are:
Byzantine capital structures: It can be difficult to know how much of the company a share is actually worth. How many warrants and convertibles are out, and at what prices? How many share classes, and what does each class do? How much of the equity is held by insiders? For example, in its initial prospectus, MedMen (OTCQB:MMNFF) listed a bewildering ten classes of equity – voting shares, subordinate voting shares, super-voting shares, redeemable units, non-redeemable units, and so on. When insiders converted various types of super shares in Trulieve (OTCQX:TCNNF), it doubled the share count almost overnight with no additional capital for the company.
Use of capital: Has management used investor money prudently? Many companies are expanding rapidly (production facilities, SKU expansion, storefronts). How well supported are the expansions in terms of competition and demand? Are balance sheets overextended? MedMen recently faced a cash balance that could have gone to zero in a few quarters. They had to assent to an onerous investment by Gotham that may dilute shareholders 20% just to keep the doors open.
Management: How well-qualified is the management to run a business? How well do their skills fit with running a business of this type? Do they have a history of success? One of the strongest teams in the industry is Charlotte's Web (OTCQX:CWBHF). It includes Deanie Elsner, former head of Kellogg's snack food division; Eugenio Mendez, former senior executive at Bacardi and Coca-Cola, and Stephen Lerner, who has executive experience at a number of pharmaceutical companies. On the other side, Harvest Health (OTCQX:HRVSF) chairman Jason Vedadi's prior experience is in real estate development.
Performance/Execution: How successful has management been thus far in the business? How do you even evaluate it when most companies are operating at a loss? Is their business plan on schedule? Trulieve is one of very few companies that have demonstrated the one essential thing in business: the ability to make a profit.
Failure in just one of these areas can mean failure of the entire company. A thorough evaluation of a single company requires much time and expertise, and even then, unknowns remain. After the most diligent due diligence, the degree of risk is still much higher than in more established industries. As every investor knows from experience, no amount of research guarantees success, and the high new venture failure rate will have its day. The cannabis environment is in rapid flux. Laws and regulations are still developing, strategies are more promise than proven, and share prices are volatile.
There is a rapidly developing alternative to trying to pick winners from among the chaos: ETFs. The cannabis ETF is a guaranteed way to participate in the tremendous growth of the industry and avoid the risks of concentrating your dollars in a handful of unproven companies. For the disciplined investor whose risk profile does not allow him or her to own small, new companies with a high chance of loss this is the only way they can participate in the industry. The granddaddy of cannabis ETFs is the ETFMG Alternative Harvest ETF (MJ), founded all the way back in 2015. There are now a variety of ETFs to suit many investors' needs. You can choose active management (AdvisorShares Pure Cannabis ETF YOLO), passive (Horizons Marijuana Life Sciences Index ETF HMLSF), led by an ETF titan (Cambria Cannabis ETF TOKE), led by a cannabis expert (Amplify Seymour Cannabis ETF CNBS), cap weighted (Spinnaker ETF Series The Cannabis ETF THCX), discretionary (CNBS), and even some that pay a regular dividend (MJ, HMLSF).
A detailed summary of all cannabis ETFs is at the end of this article.
Many investors have their reasons for preferring shares in individual companies. In this industry, in particular, it's important to have expectations that are realistic. I have a small amount in Harvest Health and Recreation, Trulieve, and iAnthus (OTCPK:ITHUF), but no illusions that my investing skills have identified the next Amazon (AMZN). I accept that any of them can go to zero. In the immortal words of Dirty Harry, “You've gotta ask yourself a question: 'Do I feel lucky?'” Lucky enough to pick a big winner from the present state of super-hype and chaos? Or would you rather lock in profitable participation in the inevitable huge growth that cannabis presents? Individual risk tolerance is an important consideration, but regardless of where you are on the risk scale, don't miss this once-in-a-generation opportunity.
Note: Numbers vary between sources.
ETF MG Alternative Harvest (MJ)
Horizons Marijuana Life Sciences Index ETF (HMLSF)
AdvisorShares Pure Cannabis ETF (YOLO)
The Cannabis ETF (THCX)
AdvisorShares Vice ETF (ACT)
Cambria Cannabis ETF (TOKE)
Amplify Seymour Cannabis ETF (CNBS)
This article was written by
Disclosure: I am/we are long TCNNF, HRVSF, ITHUF, HMLSF, YOLO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.