What’s your view on marijuana stocks? My investment-management firm has a great front-row view of the marijuana industry, as Colorado was one of the earlier U.S. states to legalize marijuana. Here’s our opinion: Making money on marijuana (cannabis with high content of intoxicating THC) and hemp (cannabis that contains low content of THC) will be extremely difficult — except perhaps in one specific area.
You don’t want to own growers. There is a good reason why pot is called weed — it is a weed. You cannot name us a single company that is the best and most profitable parsley, basil, or cilantro grower, and for good reason — these are commodities. So is marijuana. Though there are temporary abnormal profits to be captured when growing cannabis, it is restricted and tightly zoned. Once marijuana is more widely legalized and zoning laws are relaxed, capitalism kicks into high gear and excess profits get squeezed out of the system. There is no competitive advantage that can be achieved and then sustained in growing cannabis.
Then there are the medical applications — the stories we hear make you want to consume CBD (hemp extract) for breakfast, lunch, and dinner. But handicapping winners and losers in this space is difficult — a few listed companies currently trade at astronomical, dot-com-like valuations.
If indeed there are medical benefits from pot or hemp extracts, pharmaceutical companies, which have plenty of experience in conducting clinical trials, marketing, and bringing medicine to consumers, will be the ones to profit. The medical marijuana space right now looks just like dot-coms in the late 1990s: a few companies will succeed, but they’ll only be obvious with the benefit of hindsight. Most of these stocks, simply due to their astronomical valuations, will end up having a date with their maker.
Finally, you have branded recreational products. In fact, this is where the real money is going to be made. There is not much difference between marketing recreational pot and cigarettes. Again, you cannot name a wealthy tobacco grower, because tobacco, just like marijuana or hemp, is a commodity. All the value in cigarettes is captured by branded cigarette companies.
U.S. states that have legalized marijuana are collecting additional tax revenues and to some degree are reaping extra benefits at the expense of the states that have yet to legalize, as they attract marijuana “tourists” from other states where pot is still illegal.
Today recreational marijuana is legal in 10 states and medical use is legal in 23 states. Legalization for medical use has historically been the first baby step to full legalization. In a few years it’s likely that more than two-thirds of the states will have legalized marijuana.
With many states legalizing marijuana, the floodgates are open more widely, and at some point the dam will burst, as people realize the absurdity of law that makes pot legal in this or that state but illegal on the federal level. For example, recreational marijuana is legal in both Nevada and California — adjacent states — but transporting pot between the two is illegal because the federal government controls interstate commerce.
So it is really a question of when, not if, the federal government legalizes marijuana. Then it will be possible to build national pot brands. Cigarette companies are the best-equipped to be major players here. They know how to grow (or at least deal with farmers who grow) and distribute that other “weed” — tobacco. They are also great at manufacturing and marketing. They have enormous capital that they are burning to put to work. Marijuana may give them another lease on life, since their core tobacco business surely looks like a melting ice cube as cigarette smoking in the U.S. and Europe continues to decline.
How does one invest in this overvalued market? Our strategy is spelled out in this fairly lengthy article.
Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver. He is the author of “Active Value Investing” (Wiley) and “The Little Book of Sideways Markets” (Wiley).
Read: The No. 1 reason adults support legalizing marijuana (it’s not to get high)
More: Cannabis sector could grow to $200 billion in a decade
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