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Marijuana investors: How the 2020 election has changed the outlook for cannabis stocks

Voters in five states passed marijuana legalization measures. Here's what that means for investors.

Twenty/20

Although a cloud of uncertainty still hovers over the results of the 2020 election, one faction can claim near unequivocal victory: advocates of legal marijuana use. Some form of marijuana legalization was on the ballot in five states — Arizona, Missisippi, Montana, New Jersey, and South Dakota — heading into Tuesday. By the end of the night, voters in all five had chosen legalization.

Advocates of eventual nationwide legalization were thrilled. "Our victories in South Dakota and Montana, and the medical cannabis measure in Mississippi, really highlight that cannabis reform is a bipartisan (or perhaps better, nonpartisan) issue for most Americans," says Chris Lindsey, director of government relations at the Marijuana Policy Project.

Even conservative-leaning red states, traditionally opponents of marijuana reform, are coming around, he notes. "We have long operated from a strategy of moving state laws in order to change the conversation in Washington."

Investors were generally bullish on the news, too. Shares of ETFMG Alternative Harvest exchange-traded fund (symbol: MJ), which counts major Canadian growers such as Tilray, Canopy Growth, Cronos Group, and Aurora Cannabis among its top holdings, jumped 19% from the market's close on Election Day through its close on November 9.

The rise of marijuana as a legal business may seem like an inevitability, with a new Gallup poll showing that a record-high 68% of Americans now support legalization. But investors looking to ride an upcoming green wave may still want to hit the breaks and assess their options. Although state-level victories were a step in the right direction for pot stocks, there's still plenty of challenges these companies face.

Short term: Good news for U.S. operators, meh news for Canada

The appeal of investing in cannabis is easy to see. Worldwide legal cannabis sales totaled nearly $15 billion in 2019, up 46% from the year before, according to data from Arcview Group, an investment research firm specializing in cannabis, and BDS Analytics.

Researchers at investment research firm Cowen expect revenues to hit $34 billion by 2025, with the five new states contributing more than $3 billion to that projection. The expansion of the legal cannabis market into new states and the potential for "more dominoes to fall" bode well for multistate operators (MSOs), or U.S.-based cannabis firms with business in multiple states, says Dan Ahrens, chief operating officer and portfolio manager at AdvisorShares.

"There's huge upside for MSOs expanding into new states," Ahrens says. "It's practically comical that people think this benefits Canadian operators."

Although some big Canadian firms have partnerships with U.S. firms, such as Canopy Growth's deal with beverage distributor Constellation Brands, they're still barred from operating in the U.S. and won't see much benefit from the expansion of marijuana legalization here, he says. Ahrens manages the AdvisorShares Pure US Cannabis ETF (MSOS), which invests in U.S.-based cannabis firms. The portfolio, which opened to investors in September, is actively managed and carries an expense ratio of 0.74%.

Long-term: Outlook is hazy

Because of marijuana's status as a federally illegal drug, U.S.-based cannabis firms face financial obstacles. For one, their illicit status means that cannabis firms can't access banking or funding from institutional investors. U.S. growers can't ship cannabis across state lines and their stocks can't be listed on U.S. exchanges.

They take can't normal business tax deductions either, meaning pot firms effectively pay taxes on profits rather than pretax income.

Legislation that would remedy some of these issues hasn't advanced. Advocates had thought a so-called "blue wave" of Democratic victories might help. "From a legislative perspective, we were hoping that the Senate would flip," says Vivien Azer, managing director and senior research analyst at Cowen, told CNBC. "Obviously, that's still TBD."

Should Republicans retain control of the Senate, cannabis investors can expect to see movement on the SAFE Banking Act, which would legalize banking for marijuana firms, say analysts at Cowen. That's a step in the right direction, they wrote in a recent note: "It's a way to bring an all-cash industry into the banking system where money can be tracked for law enforcement and tax purposes."

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But don't expect to see cannabis firms dealing with investment banks anytime soon under this scenario, they say: "We do not see a path in this environment to open state-legal cannabis to capital markets."

If Senate Majority Leader Mitch McConnell is still running the show, you can likely forget about legalization for the next couple of years. The Kentuckian "has been a steadfast opponent who refuses to bring cannabis measures to the floor," the analysts say.

Even if the Democrats do gain control by way of the upcoming runoff election in Georgia, the body would still be split 50-50. Any tie would have to be broken by the vice president, and a single Democratic naysayer could doom potential legislative progress, they add.

For now, the long-term prospects for legal or decriminalized marijuana are improving, but incrementally, says Azer. "Now you have four Republican senators that are representing adult use states," she says. "So it helps."

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