Marijuana: Boondoggle Or Serious Investment?

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Medicinal or recreational - it's legal in some states and not in others. Where it is legal, legitimate businesses exist and are growing. Is this industry a promising investment or a high-risk venture?

Marijuana isn’t legal nation-wide, but the move for legalization is heating up. Whatever you feel about the subject, the marijuana industry has enjoyed huge growth in recent years. Many experts believe this year will be even better! So, should you invest in marijuana-based businesses? Is that even possible?

Where the Industry Stands

Right now 30 states and the District of Columbia have legalized marijuana in some form, generally medicinal or recreational. That number has grown steadily since California took the lead and legalized medical cannabis in 1996. Colorado and Washington kicked off the legalization of recreational use in 2012. Now nine states allow recreational use. Are you from the Great White North? Canada is expected to legalize recreational marijuana in July.

Not surprisingly, industry growth has been strong - up 33 percent in 2017 - and is expected to continue growing at a 28 percent clip through 2021 (BusinessInsider.com). In short, 2018 is anticipated to be a banner year for the cannabis industry.

How Can You Get In?

There are a number of ways to access the industry, including companies that grow marijuana, biotech firms that are researching and developing cannabinoid drugs, and less direct options such as fertilizer companies.

If you're interested in growers, Canada has some of the largest companies because medical marijuana has been legal up north since 2001. Some Canadian stocks are available in the U.S. via the over-the-counter market. Forget about investing in domestic growers for now. U.S. companies are hamstrung by the federal illegality of marijuana.

Several biotech companies are developing or have already developed cannabinoid drugs. These companies tend not to be "pure plays" since they often have other non-cannabis drugs in the pipeline and in production.

Investing in a fertilizer company that serves the marijuana industry would be akin to the Levi Strauss model of selling equipment to gold miners instead of doing the mining. You may not be able to figure out which growing company will succeed. But by investing in a supplier, you’ll gain access to the winners with little risk to yourself.

Finally, if you want to diversify via a fund, currently you have five marijuana/cannabis Exchange-Traded Funds from which to choose. Four of these ETFs trade on Canadian exchanges and one is listed on a U.S. exchange. However, a closer look at the U.S.-listed ETF brings us to the major issue facing investors: The ETF's custodian bank is likely debating whether or not to drop the fund amid the legal concerns associated with it.

The Elephant in the Room

So, should you be jumping onboard for the ride? Not necessarily. While a majority of states have approved the use of marijuana, it's still illegal as far as the federal government is concerned.

Under the previous administration, the U.S. Department of Justice announced that while marijuana remained illegal, the department would take a hands-off approach to enforcing those laws (effectively a drug version of don't-ask-don't-tell). The result is that marijuana-based companies operated in a grey area with respect to the law. Hands-off approach notwithstanding, banks feared repercussions from federal drug laws and were unwilling to open accounts for marijuana-based companies, which were forced to do business on an all-cash basis.

To further confuse the issue, even though producing and selling marijuana are considered illegal activities, the federal government still taxes these businesses. And the special tax is substantial - 40 percent or more (CNBC.com). Marijuana-related businesses literally delivered millions of dollars in cash to their local IRS offices for tax payments. That issue gradually subsided after a U.S Treasury ruling in 2014 provided guidance for banks and credit unions on handling marijuana-related businesses.

As an investor, the issue of federal versus state law remains very important. The fragile legal standing of these companies came into sharp focus this January when U.S. Attorney General Jeff Sessions announced he was rescinding the previous administration’s hands-off approach. Predictably, marijuana-related stocks sold off sharply in the wake of that pronouncement. The exact nature of the new approach has not yet been clarified and remains a work in progress.

Summary

In the end, investing in marijuana is mostly like investing in any industry. You need to do your research, analyzing the industry and its companies to find promising investments. The main twist in this industry - and it's potentially a big one - is the possibility of a legal shift. Unless you're comfortable with taking well-above average risks, you'll likely want to stay clear of investing in this trending industry.

David Crossman, CFA, is an Investment Manager with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email David.

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