Why should you look at cannabis stocks?

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Introduction

A quick look back at the history books reveals how certain industries have seen disruptive growth in certain time periods, and early investors of such disruptive technologies or developments not only gained substantial returns on their investments, but also helped shape a new and better world for the others. Examples include the growth of the World Wide Web, Industrial Revolution, the growth of social media, and many more.

Today, we are seeing a secular trend in the making centered on an unusual candidate; the growth of cannabis products.

Canada has remained at the forefront in revolutionizing the way investors look at cannabis products, and the Canadian government legalized the use of marijuana back in 2018, and became the first G7 nation to do so.

Along with the legalization of cannabis for recreational purposes, and for use as a medical substance, the cannabis industry is expected to grow at break-neck speeds in Canada, and many other countries are currently considering legalizing the use of cannabis for recreational purposes. On the other hand, many countries including the U.S. currently allow the use of cannabis for medical purposes.

(Source – VOX)

The wide acceptance of cannabis in the medical industry has already resulted in disruptive growth in the use of cannabis as a medical substance, and medical cannabis have been found to provide significant health benefits including relief from chronic diseases, reduced need for mental health medications, and reduced deaths from Opioid Overdose.

A number of Canada based cannabis companies have successfully listed their shares on U.S. based stock exchanges as well, and these stocks have so far provided stellar returns to investors, despite some of these companies are failing to make ends meet at the moment.

The North American Marijuana Index; a stock market index with a focus on North American listed companies that have a business strategy focused on the marijuana or hemp industry, has provided outstanding returns since its inception in 2015.

With 46 constituents, the North American Marijuana Index has gained 170.6% over the last 4 years, which is a significant outperformance of the 38.6% gain of the S&P 500 Index in the same period.

Performance of the North American Marijuana Index since inception

(Source – Marijuana Index)

Despite the stellar returns provided by cannabis stocks over the last couple of years, and the improving regulatory outlook for cannabis on a global scale, many investors are continuing to avoid investing in the industry due to a lack of understanding on the cannabis industry and the underlying growth factors.

The growth expectations

The global cannabis market is expected to grow at a Compounded Annual Growth Rate (CAGR) of over 31% through 2023, and will grow from $10.3 billion in 2018 to $39.4 billion in 2023. This stellar growth is expected on the back of the expectation that many regulators around the world will legalize the use of cannabis for medical and recreational purposes.

At present, the cannabis industry faces headwinds by way of regulatory pressures and supply shortages, but this has been the case for many growing industries at early stages. As such, it would be natural to see an elevated level of volatility in listed cannabis stocks in the short-term, but such volatility should be considered as an opportunity to invest in a sector that is still in its infant stage.

From the standpoint of cannabis product sales, regulatory approval by key jurisdictions such as the U.S. and Europe will remain the catalyst. To this end, investors should pay close attention to the decisions taken by the Food and Drug Administration (FDA) of the U.S., and the decisions taken by the European Union regarding the sales of cannabis.

The FDA is holding a public hearing on May 31, 2019 to allow stakeholders to share their experiences and challenges with products containing cannabis and cannabis-derived compounds, and we view this as a progressive step toward legalizing the use of cannabis in the U.S. A positive outcome from this public hearing will result in a massive boost to the cannabis industry, and all eyes are on how the FDA moves forward in legalizing the use of cannabis.

Focusing on Europe, Luxembourg is expected to legalize the use of cannabis for recreational purposes in the near future, and will eventually become the first European country to do so. In our view, this will lead to a massive growth opportunity for the cannabis industry, and the European Union will probably accelerate its process of legalizing cannabis in Europe.

Even though Canada has so far led the charge in driving the cannabis industry higher over the last many years, the U.S. might steal the spotlight from Canada in 2019.

Many U.S. states have already approved the use of cannabis for medical purposes, and as many renowned pharmaceutical companies and healthcare companies use cannabis products, we will see robust growth in the demand for cannabis in the U.S., and the recent reports released by the Marijuana Business Daily confirm this thesis.

(Source – Marijuana Business Daily)

Marijuana prices will continue to drop as the industry matures

Marijuana prices have drastically come down in Oregon, Colorado, and Washington over the last 4 years, and we expect this secular trend to remain true in the future as well on a global basis.

One of the major factors driving this secular trend is the increasing competition in the industry. As competition heats up in the industry, cannabis product manufacturers would be forced to lower the prices of their end products to retain their market share of the industry, which is true for any industry. As marijuana prices go down, we expect the appeal of cannabis usage to increase on a global basis, which should result in a higher consumption of cannabis products. This was the case in the aforementioned States over the last 4 years.

However, the declining prices will prove to be a headwind for many small cannabis companies, and investors should be prudent enough to invest in companies that are producing cannabis products on a large-scale as these companies would be able to take a cut in their profit margins to increase their market share, which would lead to competitive advantages in the long-term.

Major risks of investing in the cannabis industry

Adverse regulatory developments remain the key risk of investing in this growing sector, and many countries are still reluctant to approve the use of cannabis for recreational purposes. However, this risk will diminish with the expected approvals from a few European countries and the U.S. In any case, long-term investors should find the risk-return profile of investing in the cannabis sector to be attractive, considering these regulatory pressures will cease to exist in the long-term as legalizing cannabis usage will prove the best way for regulators to demotivate illegal usage of marijuana, and to promote the usage of cannabis in the healthcare industry.

As with any other booming industry, another risk faced by cannabis investors is the possible delay of social acceptance. Once again, this applied to short-term investors, and long-term investors should look beyond such near-term woes.

On the other hand, picking the wrong company to invest in to gain an exposure to this booming industry will result in unexpected losses for investors, and understandably, not all cannabis companies are expected to provide the same level of investment returns. Therefore, thoroughly understanding the dynamics behind the cannabis industry and identifying a company or companies to invest in would be the best way forward for investors.

Conclusion

The cannabis industry has come a long way from its humble beginnings a few years back, and the industry is poised to grow exponentially over the next decade. Regulatory approvals will become the catalyst for such growth, and prudent investors stand to gain from the growth of this industry. As such, as an investor, you should keep a close eye on cannabis stocks and the cannabis industry as this is one industry that has the potential to provide you with significant gains in the future. However, investors should keep in mind that this article does not intend to provide advise on investing in the cannabis industry, but rather, acts as an information document to outline the expected growth of the industry.