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Investing in Marijuana Through the Stock Exchange: the Risks and the Potential Rewards

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July 26th 2018 proved to be the date that the UK finally caught up with much of the rest of the developed world and legalised the prescription of medical marijuana. Home Secretary Sajid Javid made the announcement that many expected would eventually come following the public outcry provoked by the confiscation of a small boy’s epilepsy treatment last month. However, perhaps even the more optimistic campaigners for medical marijuana would yesterday have been surprised quite how quickly the tide has turned.

Earlier in July the UK took a massive step towards giving GPs permission to prescribe medical marijuana and cannabis-derived products. The UK’s official independent advisory body on drugs, The Advisory Council on the Misuse of Drugs, gave its recommended to the government to allow such prescriptions within the framework of ‘appropriate safety standards’. The recommendation was based on ‘evidence of medical benefit’ of some medical marijuana-based products for some conditions.

While many UK investors will have for some time been aware of this exponentially growing sector, it will only have been the rapid acceleration towards the process of legalisation in the UK over the past month or so that will have alerted you. The UK has been, despite ironically contributing some 70% of international exports of medical marijuana worldwide in 2016, a laggard within the context of developed Western economies, a laggard when it comes to revising legislation. Australia, Canada (where recreational use will also be legalised by the end of summer 2018), 30 USA states, Germany, Switzerland, Denmark, Finland, Luxembourg, the Netherlands, Norway and even, perhaps surprisingly, Turkey have all already made the step.

That list of countries is far from complete and slowly but surely, it now seems to be an inexorable international process that will play out over the next decade, medical marijuana and derived drugs is being legalised. Despite the legacy perception of marijuana, or cannabis (two different names for exactly the same plant) as a psychedelic drug for hippies and drop-out students that still remains, the mounting clinical evidence of its medicinal properties is becoming overwhelming.

For and Against Medical and Recreational Marijuana Use and the Changing International Landscape

Medical marijuana are strains developed to have extremely low levels of THC, the compound which leads to the ‘high’ associated with recreational use. There is evidence that heavy, prolonged recreational use can lead to dependency and increases the risk of anxiety, paranoia and psychotic illnesses such as schizophrenia. Those risks are thought to be higher in adolescent users whose brains are still developing. Cannabidiol, or CBD, the other major active ingredient in marijuana, dominates in medical strains and counteracts the negative effects that can result from THC. In fact, one of the applications of medical marijuana backed by the most clinical evidence is in treating anxiety and depression.

However, attitudes towards recreational use are also softening. While few argue that there are not dangers inherent in abusive recreational use of marijuana, they do argue that it does not represent any greater risk than abuse of other legal substances, namely alcohol. Rather, there is significant evidence to suggest that the latter carries far greater risks in terms of its addictiveness, impact on health and the social and personal fall-out that results from over consumption. It doesn’t take a medical expert to come to the conclusion that spending a significant portion of one’s waking hours intoxicated, regardless of the source of the intoxication, will be harmful both in terms of living a productive life and impacting health.

There is no recorded case of death resulting from overdosing on marijuana and modest, responsible consumption also appears to be low risk. There are strong arguments for the legalisation of recreational use based on this and the fact that a legal, regulated market would offer several other advantages. THC levels could be controlled, with the strongest strains of ‘skunk’ marijuana blamed the majority of negative psychological impact that results from overuse. Legalisation of what is already a relatively accessible black market would also cut off a major revenue stream for organised crime, lead to huge savings for police forces and simultaneously raise vast amounts of new tax revenue for governments.

The Future for Legal Recreation Use of Marijuana

Canada will fully legalise recreational use in late summer 2018 and 9 U.S. states + Washington DC have also already made the move as have Spain and Uruguay. A quickly growing list of other countries have decriminalised recreational use, which means it is not strictly ‘legal’. There are not shops or legal vendors of marijuana but possession up to a certain quantity, considered to be for personal use, is not a criminal offence.

The trend towards the legalisation of recreational use of marijuana can be expected to unfold at a slower pace than is currently turning out to be the case for medical use. Nonetheless, while it may be a patchwork process with an unclear timeline, the wheels are already in motion. It is a relatively safe bet that within 5 years several other major nations will have taken the step and many more within 10.

Investing in Legal Marijuana Through the Stock Exchange

With the rapid legalisation of medical marijuana and the more tentative legalisation of recreational use comes a huge investment opportunity. Hexa Research forecasts that by 2024, the medical marijuana market will be worth almost $20 billion in the US alone. The black market for recreational use in U.S. states where the drug is still illegal is estimated at $46.4 billion and £2 billion in the UK. Eventually, that should become a legal market and its value transferred over to the official economy.

As such, it should come as no surprise that the rush to invest in stock market listed marijuana companies has been likened to the dotcom boom. There are now numerous listings on Canadian stock exchanges, a quickly growing number on the Nasdaq and a handful of passive tracker ETFs and managed funds that focus exclusively on the sector. July’s move to allow the prescription of cannabis-derived medicines in the UK could eventually open the door to medical marijuana stocks on the London Stock Exchange.

British biopharma company GW Pharmaceuticals whose marijuana-based multiple sclerosis treatment Sativex was the first drug of its kind to be approved in any country is listed on the Nasdaq in the USA. That decision was largely made due to a capital market with friendlier inclinations towards medical marijuana stocks than the UK’s represented. Hopefully the legislative and attitude changes now afoot in the UK will mean the next promising marijuana biotech or biopharma company will feel confident enough in the domestic capital markets to list at home in London.

Higher net worth and sophisticated investors may see interesting opportunities to invest in riskier pre-IPO companies in the medical marijuana space. However, for retail investors, the stock market is a lower entry level, lower risk way to gain exposure to the medical and future recreational legal marijuana market. It also allows for affordable diversification between numerous companies in the sector, spreading risk.

However, like any new, high growth market the big opportunities the legal marijuana sector offers inherently entail not insignificant risks. Let’s take a look at some of the main considerations for those thinking of investing in marijuana through listed equities.

Legal Marijuana Stocks: The Opportunity

Huge Growth: the legal marijuana sector is, as Arcview Market Research puts it ‘arguably the fastest-growing industry in the world’. And it’s hard to argue the opposite side, at least in terms of an industry at any real scale. In the USA and Canada alone the market is expected to see a huge 27% compound annual growth rate to $22.6 billion by 2021. If the trend towards legalisation of recreational use continues, and it is expected to, those figures will pale into insignificance.

Many observers say the only comparable market in modern history is that for alcohol following the end of prohibition. Imagine having made a small investment in Jack Daniels then!

Diversification: investing in the legal marijuana industry through equities offers a level of diversification not available through private investment in start-ups. There are now a number of ETFs in the space that allow investors broad-based exposure and which have different focuses. For example, the Marijuana Life Sciences Index ETF, currently the largest marijuana ETF, is made up of stakes in life sciences companies with significant interests in the medical marijuana industry. Another ETF, the Horizons Junior Marijuana Growers Index ETF is focused on companies involved in the cultivation and distribution of legal marijuana. Others have different focuses and strategies and some are passive index trackers while others are managed.

Legal Marijuana Stocks: The Risks

The opportunity investment in the legal marijuana sector represents is fairly straight forward. It’s both a brand new market and one for which there is proven, huge demand. It will be a huge industry within a decade and the right early bird investments now will almost certainly result in returns difficult to match.

The risks are that the legal marijuana industry is early stage, immature, there is a lot of hype around it and listed companies are subject to a host of uncertainties. That, unfortunately, is the risk to reward balance that huge opportunities represent. When it comes to investing there is no such thing as a free lunch. Here’s a breakdown of some of the most obvious risks that must be understood by anyone investing in legal marijuana stocks.

Regulatory and Legal Uncertainty: judging the future growth potential for marijuana stocks is difficult because while the legal and regulatory environment is changing favourably across the world there is no clear timescale for when new markets will come ‘online’. In the USA, for example, there were fears the Trump administration could revoke the right of individual states to set their own marijuana laws. The drug is still illegal at a federal level. These concerns have since receded but the current status quo still represents a risk as changes can’t be excluded as a possibility.

In the UK, for example, medical marijuana will now be available with a prescription. But we don’t know how tight control over those prescriptions will be. Will recreational use be legalised too in the next 5 years? Maybe, maybe not. 10 years? Probably, but perhaps not. The same questions across most international jurisdictions make growth potential analysis of the industry very difficult.

Volatility: stock market traded legal marijuana equities and ETFs are notoriously volatile. An immature industry, regulatory and legal uncertainty and a higher than usual presence of fidgety retail investors all contribute towards this. Early stage biotech and biopharma stocks are always volatile and soar and slump based on sentiment and progress around clinical trials. This is magnified in the case of cannabis-focused biotech stocks.

Early Hype: the arguments for why legal marijuana will be a huge industry are so clear it is hard not to be convinced. However, while this has boosted the sector by making capital available to stock market listed companies in the industry, it is a double-edged sword. Many analysts believe the hype around the industry means that the majority of legal cannabis stocks are currently over-valued. Investors are paying a premium for the undoubted growth the industry will have.

The problem is that not all of the first companies in the market, including those who have gone public, will be lasting players. An immature market is less punishing than a mature one and it is almost certain that many of the first cannabis stocks will prove to be flops, taken over by more professionally run operations as the market matures. Some will of course be successful and go on to valuations that are many multiples of those that might currently be considered as high. A look at the tech industry is enough evidence of that. But investing at this stage inherently involves the risk of buying into companies into the former rather than latter category.

High Risk, High Reward

Investing through ETFs spreads the risk across multiple companies in the sector but should still be considered high risk for an equities investment at this stage of the industry’s development. The opportunity for spectacular returns is clear but for now legal marijuana equities and ETFs should be considered high risk and not suitable for retail investors who should err towards the conservative, unless as part of a small ‘high risk, high reward’ allocation in a portfolio.

Risk Warning:

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

Paul

The author Paul