ILLUMINATION
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ILLUMINATION

A Simple Guide to Investing in Marijuana

A Little About your Author: Fraud Stamp is a small team of experts in personal finance that offers a range of free resources including online courses, books, and reports to educate investors in the field of finance and investing. You can visit our website at www.fraudstamp.com or follow us on Twitter and Instagram @FraudStamp.

Photo by Manish Panghal on Unsplash

Is marijuana really the next big investment opportunity? That crucial question is the focus of this article.

Before we can fully explore that question we must understand the current state of the marijuana market and what the future looks like. If you mention the word marijuana to anyone over the age of 60 the immediate response is ‘That is illegal!’ And they are dead right, it is illegal. But like most things, the word ‘illegal’ is relative.

Let us start by providing you with a smattering of random facts about marijuana that will provide you a taster for the subject before we dive into the detail.

A Few Interesting Facts to Kick off

  • According to the 2019 edition of the United Nations’ World Drug Report cannabis is the most widely used drug in the world with an estimated 188 million people having used it over the previous year
  • At least 135 countries representing 92% of the global population engage in some form of cannabis cultivation
  • Cannabis is native to India and Central Asia
  • The US market is by far the biggest — representing 25% of the total cannabis market, with only 5% of the population (incidentally, cannabis and marijuana are interchangeable words — cannabis is easier to spell!)
  • At a federal level in the US cannabis is illegal
  • Recreational marijuana is legal in only two countries, Uruguay and Canada.
  • In December 2018, the 2018 Farm Bill in the US was signed into law, this allowed for the legal growing and distribution of hemp and cannabis with no more than 0.3 percent THC (see definitions below)
  • In 2018 over forty million Americans reported using cannabis
  • Two thirds of Americans favor cannabis legalization
  • In the US thirty five states have a medical cannabis program and eleven are fully legal including both medical and recreational (as of November 2020).
  • By 2024 the US legal cannabis market is set to be worth $42bn from its current level of around $13.6bn.
  • The legal cannabis market grew by 42% in 2019, total cannabis sales grew more than 30% for the fifth consecutive year
  • Over 260 million adults worldwide consume cannabis at least once per week, collectively spending $344 billion (Source: New Frontier Data)
  • Approximately 20% of the US adult population consume cannabis, whilst 12% are consistent consumers
  • California is the biggest market in the world
  • In 2020, it was found that the average amount each US cannabis consumer spends annually on cannabis products range between $500 to $2,500
  • Although cannabis is legal in Canada estimates are that the black market represents 71% of the market
  • US operators have the best technology, genetics, growing conditions and product innovation in the world despite being restrained by federal law
Photo by Roberto Valdivia on Unsplash

Some Basic Definitions

In order to better understand this subject we must also understand some of the expressions and terminology that are used in the marijuana industry. Below are the most important ones.

CBD — One of over 100 cannabinoids, which are compounds found throughout cannabis and hemp plants. CBD does not produce a ‘high’ and is often credited for offering therapeutic health benefits.

THC — The most infamous cannabinoid is THC or tetrahydrocannabinol. This is responsible for the feelings of euphoria and intoxication associated with the consumption of cannabis.

Hemp — Industrial hemp is defined by federal law as cannabis plants that contain less than 0.3% THC. It has various uses, including rope and textiles. The root of hemp is used for medicine.

Strains — There are many different strains of cannabis. They can be further broken down into three varieties: sativa, indica and hybrid. Sativa strains produce a more uplifting and euphoric feeling and is recommended for daytime use. Indica strains generally provide a sense of deep body relaxation. Hybrids are created when an indica and sativa plant are bred together. However there is no official research into the sativa v indica effects. Plus everyone processes THC differently, so these are only rules of thumb.

Top 5 strains

  1. GSC $275 per ounce
  2. Purple Punch $410 per ounce
  3. GG4 $375 per ounce
  4. Vanilla Frosting $318 per ounce
  5. Sour Diesel $288 per ounce

OG — The most famous strain is probably OG Kush, a long running staple of the California global cannabis scene. This is a strong indica strain. Some say it stands for Ocean Grown as in, grown along the Californian coast. It has been consistently measured at 20 to 25% THC, which is strong!

Flower cannabis — Otherwise known as weed. It is the most popular method of obtaining and consuming cannabis.

Concentrates — It looks like honey or butter and is often called honey oil. It contains high levels of THC — from 40 to 80%, it can be 4 times stronger than high grade or top shelf marijuana.

Edibles — These can take many forms from capsules to brownies.

Cannabinoids — The active chemicals in medical marijuana — these chemicals are similar to chemicals the body makes that are involved in appetite, memory, movement, and pain.

Dispensary — The retail outlet where marijuana is sold.

DEA — The Drug Enforcement Administration is a US federal law enforcement agency. Not someone you want to have knocking on your door late at night!

FDA — The US Food and Drug Administration is a federal agency of the Department of Health and Human Services.

Legal v’s Illegal

In the US, by far the biggest market for cannabis in the world, Marijuana is still a controlled substance under federal law and is on the DEA’s Schedule 1 list of substances, up there with heroin. What that means in plain English is that marijuana is illegal on a federal level.

Although there are multiple states that allow the sale of recreational and medical marijuana these states are breaking federal law. If the government were so minded they could come down very hard on anyone who cultivates, distributes, sells or buys marijuana even if all this activity was confined within state lines. That is not a great position to be in. It cannot even be said that marijuana is in a grey area.

In the days of the Obama administration the government was aware of this disconnect and issued a memo (the Cole memo) to clarify the situation thus tolerating this incongruous position. Trump predictably withdrew the memo and has taken a ‘blind eye’ approach to what is going on in various states as regards cannabis.

It is much anticipated that if the Democrats take control of the Senate marijuana will finally become legal on a federal basis. It would be extremely unlikely if cannabis didn’t finally become legal in the next 10 years, some are saying that this scenario is a possibility within the next two years.

What is interesting however is if marijuana becomes legal on a federal basis it does not mean the black market suddenly disappears. In California, where recreational marijuana at a state level was made legal in 2018 the black market represents over 75% of the total market.

There are many reasons for this including the price differential because of the high taxes on legal marijuana and the convenience and habitual factor of continuing to deal with your friendly drug dealer. In California legal marijuana costs 10% more than the illegal market.

However this is where the opportunity for growth sits. Older people who don’t want to break the law, people new to the market who discover new ways of consuming marijuana, people who prefer to buy online and those who wish to slowly transition to buying through legal channels.

In order to fully appreciate the marijuana investment scene we must understand the legal nuances. We have set out some of the legal considerations when operating in the marijuana market.

Within State Lines — It is illegal to transport cannabis across state lines. What that means is that as a retailer you must buy from a licensed supplier in your state. And as a supplier you must only supply to licensed retailers or dispensaries within the same state as your production facility.

Export — Following on from the above point, in the US a legal (or illegal for that matter) cannabis operator is not able to export marijuana to other states or countries.

Banking — Because marijuana is illegal at a federal level federal banks are not permitted to provide banking services to companies engaged in the cannabis business. This is governed by the 1970 Bank Secrecy Act. This law even covers those operating as medical marijuana companies.

Insurance — As with banking, companies in the cannabis trade are unable to take out insurance with federally regulated insurers.

Payment processing — Because of the restrictions on banks providing services to companies engaged in the marijuana business operators mainly deal in cash and are unable to take advantage of bank payment processing services including those provided by the likes of Square, Google Pay, Apple Pay and PayPal.

Access to capital — Although there are a number of specialist investors in this market many of the mainstream lenders such as banks and financial institutions are not able to provide funding to this sector severely restricting the ability of companies to raise capital.

Mergers and Acquisitions — There have been a few notable investments made by mainstream liquor and tobacco conglomerates into Canadian companies where cannabis is legal. But the same cannot happen in the US until cannabis becomes legal federally. Again this presents a huge opportunity for the future.

Tax — US Tax code Section 280E stipulates that distributors of a controlled substance (of which cannabis is one) cannot write off any expenses (rent, wages and overheads) against revenue. Tax rates vary by state from 6.25 to 25% depending on the THC concentration.

Marketing — The FDA generally punishes companies that make health claims about drugs that the FDA has not approved. It does not do so for THC bearing marijuana however it does step in where it sees misleading advertising on CBD based products. Organic marketing is by far the best investment. Organic results generally do not have restrictions that paid advertising does. Facebook and Google restrict cannabis and related advertising. Generally speaking ads cannot show images and the messages cannot show consumption. They also cannot target minors. As well as organic marketing other opportunities to promote a marijuana based brand is through PR, sponsored content and building a community. Source: Illumination Consulting https://illuminationconsulting.com/cannabis-cbd-marketing-restrictions/

Medical v’s Recreational

Photo by Elsa Olofsson on Unsplash

It is claimed that cannabis has over 400 health benefits. However the reality is there is very limited solid evidence including clinical trials to back up these claims. Limited research however suggests cannabinoids might:

  • Reduce anxiety
  • Reduce inflammation and relieve pain
  • Control nausea and vomiting caused by cancer chemotherapy
  • Kill cancer cells and slow tumor growth
  • Relax tight muscle in people with MS
  • Stimulate appetite and improve weight gain in people with cancer and AIDS

To put these optimistic claims into perspective the National Academies of Science, Engineering and Medicine reviewed the scientific literature concerning marijuana’s health effects, good and bad. It found substantial or conclusive evidence for only three benefits (treating nausea, chronic pain and spasticity associated with multiple sclerosis) and moderate evidence for one other (sleep disturbances associated with certain conditions).

So whilst marijuana has many potential benefits, these benefits have been arrived at with limited testing. However evidence is only going to build to support these claims over time, with obviously some falling by the wayside and other new ones being discovered.

How do you Take It?

We agree this is a stupid question on the face of it. But it is worth exploring because we believe that this very question forms the basis of the potential of this market. These are the five methods:

  • Smoke it
  • Inhale through a vaporizer
  • Eat it — capsule brownie
  • Lotion to apply to skin
  • Place a few drops of a liquid under your tongue

The potential is in the non smoking method. Particularly for non smokers where a capsule or a brownie is going to be preferable to a glass bong.

Pricing

It is estimated that legal marijuana is 10% more expensive than its illegal counterpart. The average retail price in the US based on medium quality is $299, it is highest in the East, $319 and lowest in the West, $274.

Here are a few sample prices per ounce by strain:

Illinois $480 Double Dream

Wyoming $140 Durban Poison

Mexico $50 The lime

Venezuela $140 Columbian Gold

Australia $400 Bubblegum

The Most Expensive

The most expensive countries to buy marijuana in the world is the United Emirates with an average price of 102 euro per gram, next is Brunei at 68 euros per gram, Japan at 63 euros, Estonia 23 euros, Singapore 20 euros and Ecuador 19 euros.

The Cheapest

India is the world’s cheapest. At 0.08 euro per gram, the cannabis plant is native to India. South Africa is next at 0.092 euro, Nigeria 0.185 euro, Brazil 0.278 euro, Columbia 0.370 euro, Dominican Republic 0.463 euro, China 0.740 euro. Out of interest Afghanistan is about 4 euro per gram.

1 Euro = 1.20 USD

Markets Outside the US

Although the US market represents 25% of the global cannabis market it is projected that legal cannabis sales are projected to represent 72% of total global sales by 2025.

Outside the US there are only two countries where recreational marijuana is legal, Canada and Uruguay.

A few other countries of note include:

  • Israel — One of the top medical cannabis importers in the world. It also has one of the most progressive medical cannabis industries in the world.
  • Luxembourg — Although a small country it is expected to be the first in the EU that makes recreational marijuana legal.
  • Germany — has the biggest market for medical use cannabis in the world and the largest importer.
  • Italy — Is the second largest for medical use marijuana.
  • Argentina, Columbia, Chile and Peru permit medical use marijuana.
  • Australia and NZ — allow medical use marijuana.
  • England — allow medical use marijuana, although there are many restrictions which have severely restricted this market.
  • Mexico — Is close to legalizing recreational marijuana although it could be a few years before various hurdles/formalities are overcome and consumers can start buying legally.
  • Cannabis in all forms is illegal throughout Asia although Thailand began allowing medical use of cannabis and more recently allowed it to be infused into food stuffs.

Where is the Money being Spent?

The vast majority of money is being spent on flower cannabis. That market represents over 50% of the total market, in some states it is over 70%. Concentrates and edibles are eating into this market as they experience higher growth. There is also an increased use of vaping products which despite a setback have carved out around 10–15% of the market and growing. The reality is for this market to grow and become mainstream there must be alternatives to the bong and the ‘joint’ and this is where vaping and edibles can potentially expand this market beyond all recognition.

Licensing

When a state legalizes cannabis that doesn’t mean that anyone can open up a store and start selling marijuana. This is only the first step. However it does depend on the state as some have made the process more complex than others. Take California for example. California has one of the most complex systems in place. With 58 counties and 482 incorporated cities, each municipality has the power to create their own unique set of requirements. Although already a big market it still has massive potential as only 20% of California’s cities have implemented cannabis regulation.

A wannabe cannabis grower or retailer will have to obtain a license and that is not a cheap process. In California there are a range of annual fees payable ranging from ‘Speciality Cottage Outdoor’ at $135 per year to ‘Medium Indoor’ costing $77,905 a year. The Colorado system is more streamlined with only 6 tiers compared to Californians 16. Fees are also significantly cheaper with a maximum annual fee of $5,300.

Many states and municipalities restrict the number of cannabis businesses. As well as licensing requirements some of the other barriers to entry include high application fees, strict regulations, stringent financial reporting and management requirements. Patience is essential when applying for a cannabis license. It can take over two years and costs can reach $300,000 plus.

A Few Myth Busters

There are many myths floating around about the effects of marijuana use. Here are the main ones.

You can’t overdose on weed…

You can, but it won’t be fatal.

Weed is not addictive…

It is. The addictive potential of marijuana is linked to THC.

It is a natural plant so it can’t be that bad…

While it can’t directly kill you, it isn’t risk free. Regular marijuana use has been shown to be associated with long term problems, including poor academic performance, memory loss and lung cancer. To a developing brain, like those of teenagers, marijuana can be especially toxic.

Marijuana use causes cancer…

It’s true that marijuana smoke, like tobacco smoke, contains carcinogens. But even hardcore pot smokers typically consume much less pot than tobacco smokers do cigarettes, probably not enough to cause cancer.

Marijuana is a ‘gateway’ drug…

People who use marijuana are statistically more likely to go on to use other drugs, but that doesn’t mean marijuana use causes use of other drugs. A report by the Institute of Medicine found ‘no conclusive evidence that the drug effects of marijuana are causally linked to the subsequent abuse of other illicit drugs’.

Growing cannabis is easy money…

It is true that the profit margins are extraordinarily high in the cannabis business. There is also a mismatch of demand and supply in most states with insufficient legal dispensaries to fulfill demand. But to counter this there are many issues that make this a hard business to operate in including high set up costs, regulation, security, specialist skills required to ensure a consistent quality crop and of course competition, not just from other legal operators but from the black market.

The Future

The recent US election saw five further states legalize marijuana in some shape or form. The potential however is all wrapped up in whether marijuana is legalized on a federal level. There is a possibility that the control of the Senate could swing to the Democrats as early as January and whilst legalization would not happen immediately it would definitely increase its chances in the short to medium term and probably by the end of Biden’s first term. The legalization of marijuana on a federal level is a game changer on so many levels.

It would legitimize many of the US operators allowing them to make the most of their economies of scale and export across state lines and as significantly export to countries that allow medical marijuana. It will allow companies to access capital and drive expansion. Also, as we saw in Canada, it is likely that mainstream tobacco and liquor companies will make strategic investments and acquisitions in the US which they are prevented from doing now. Legalizing the industry will provide many opportunities bearing in mind however that there are many a slip between cup and lip!

There is one other major development apart from the legalization of marijuana on a federal level and that is something called The SAFE Banking Act — The Secure and Fair Enforcement Banking Act. This bill allows cannabis businesses to work freely with banks. This is currently a major obstacle for marijuana businesses as regards payment processing, access to working capital and other banking services. The House passed the bill back in May 2020 and it heads to the Senate which has never passed cannabis banking legislation. It is unlikely however this bill will pass without the Democrats taking control, but there is a chance.

Investment Opportunities

‘As of 2018, US recreational and medical cannabis have penetrated just 8% and 21% of their estimated markets, respectively. Based on our state by state analysis we forecast nearly 25% average annual growth for the US recreational market and nearly 15% for the medical market through 2030.’ Morningstar

This is the opportunity, without federal legalization. With federal legalization the opportunity becomes so much bigger.

What we are going to explore in this next section is how as an investor we can benefit from this phenomenal growth.

Cannabis related companies fall into a number of categories including agriculture, retail, pharmaceuticals, biotechnology, healthcare, household products, cosmetics and even real estate trusts.

How Listed Cannabis Investments Work

Cannabis stocks v traditional stocks

Publicly traded stocks on major exchanges usually have at least 70% of their shares held by institutional investors. Because US based cannabis companies are reliant on private sources of capital to fund their business retail investors typically make up 91% of all cannabis stocks. This makes for a very volatile stock price.

Generally Canadian cannabis companies can list in the US and the Toronto Stock Exchange (TRX). US based cannabis companies however have limited options. Exchanges in the US are out of bounds for them. Their options are restricted to the US over the counter market (i.e. matched bargain) or a listing on the smaller Canadian Stock Exchange.

Investors wanting exposure to the US market should be targeting US based companies as their Canadian counterparts are unable to operate in the US. Although Canadian cannabis stocks do have potential with their ability to export to other markets in our opinion the action is in the US.

So how do investors gain exposure to the US market?

They can invest in a range of listed US stocks on the Canadian Stock Exchange or the US OTC but we must remember these stocks are volatile and in the main illiquid meaning to purchase a meaningful amount of stock the spreads are potentially substantially wider than quoted. Below are four US based companies that are worth a closer look:

Curaleaf (CURA) $7.10bn Dispensary operator

Green Thumb Industries (GTII) $4.70bn Dispensary operator

Trulieve Cannabis (TRUL) $3.88bn Focused on medical in Florida

Cresco Labs (CRLBF) $3.78bn Dispensary operator

The only problem is many of these stocks have increased in value by over 300% from their low point in 2020 thus already factoring in the good news in the market. However an investor can look to buy on weakness and accumulate stock in these larger operators. Alternatively search out smaller operators which are only just emerging. Although a higher risk strategy you could add one or two of these smaller companies to a larger portfolio of US based cannabis stocks to diversify company risk.

Rather than conducting your own extensive research you can buy an ETF (exchange traded fund). There are a few of these to choose from all offering different strategies and varying sizes.

The two top ETFs in this space are:

ETFMG Alternative Harvest with a market cap of $1.25bn. This ETF has a holding of 50 stocks with just 7 stocks representing 65% of their holdings. Much of the exposure however is in Canadian based companies with the exception of GW Pharma a UK based medical marijuana drug development company.

Horizons Marijuana Life Sciences with a market cap of $740m. This ETF is mainly focused on the medical marijuana market.

There are a number of other cannabis focused ETFs but these are much smaller i.e. sub $50m. And whilst many of these do focus on the US market their small size means trading in them can be expensive. One of the better ones is AdvisorShares Pure Cannabis ETF (YOLO). Its assets under management is around $62m and is primarily focused on US and Canadian based companies offering consumer products.

Investing in cannabis stocks is probably the safest way to gain exposure to this market — although safe and cannabis does not go together. Some may say we are in a bubble right now with the recent massive increase in share prices. If you are a risk taking value seeking investor what other options are available to you?

Crowdfunding — There are a number of specialist crowdfunding platforms that specialize in cannabis based businesses. This is a high risk high reward way of investing. One of your main considerations is to ensure that the valuation is not ridiculous — that is the sin of many of these platforms. In crowd funded or private investments it is imperative you conduct your own due diligence on the management team and the opportunity. Don’t take the entrepreneurs word for it. However there will undoubtedly be a few gems amongst the crap where you are able to invest at the ground level of a startup. But be very careful.

Cryptocurrency — Believe it or not there is an opportunity to buy cryptocurrencies that have exposure to the cannabis market. A few cryptocurrencies are looking to assist the cannabis market in overcoming its reliance on cash. A good cryptocurrency solution in this space is long overdue and could be very lucrative.

An Alternative Investment Strategy — The cannabis market can be broken down into plant touching and ancillary. A wise investor may look to explore opportunities in the ancillary market which isn’t quite so hot as the cannabis touching market. It is a forgone conclusion that if and when federal law changes the competition will heat up to the point where there will be an oversupply. By selling picks and shovels, as in the days of the California gold rush, this could be a good investment strategy in preparation for the arrival of the real green rush.

Risks from Scammers

We hope you all realize that wherever there are big opportunities it is fertile ground for the scammer. That will take many forms including overvalued or fictitious companies listed on crowdfunding sites. Investment schemes offering above average returns, limited time opportunities to invest in the next big thing. A popular ruse is ’buy now before we are granted our license when the stock price is going to skyrocket’ the problem is there is no license. Avoid the get rich quick schemes.

Conclusion

2019 was the year of the bear in the marijuana market. Prices plummeted when it became obvious that stocks had been overbought on unrealized promises. Companies continued to make big losses and failed to realize the potential.

The potential since the US election is even greater compared to 2018 before the market correction. Prices of listed cannabis stocks however have raced ahead in anticipation. In our opinion they are due for a major correction however that assessment could all change if marijuana becomes legal at a federal level. The market will quickly overlook the problems at the micro level as it races ahead. The big question is do you buy now or wait?

It is never a good time to buy. It is always a good time to buy. We think that investors should consider buying exposure to the market now but keep some powder dry to see how things play out in the next six months. And remember only invest what you can afford to lose because with this hugely volatile market prices could easily halve if the market becomes nervous over slow progress or an unexpected sidewinder.

Visit us at www.fraudstamp.com or follow us on Twitter or instagram: @fraudstamp

No Financial Advice

This article does not constitute financial advice in any way. The article should be treated as supplementary information to add to your existing knowledge

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Fraud Stamp

Fraud Stamp

A wise investor is a well informed investor. We aim to identify and help investors manage risk. From cryptocurrency to property, from stocks to fine wine.