Investing

Marijuana stocks and the 2020 election: What you need to know

A “new-look” government led by Presidential candidate Joe Biden could potentially accelerate marijuana legalization. Here’s what investors need to know.

Twenty/20

As Americans head to the polls this November to chose between red and blue candidates, they'll be making a decision on a certain green substance as well. On Election Day, voters in five states — Arizona, Mississippi, Montana, New Jersey, and South Dakota — will decide whether or not to legalize marijuana for recreational or medical use, or both.

For now, medical cannabis is legal in 33 states and the District of Columbia, and 11 of those states, plus the District, allow recreational use. But even if pot isn't on the ballot in your state, your vote is still likely to affect the direction of U.S. cannabis policy over the course of next few years. More relaxed policies on the potent plant could ease financial challenges for the marijuana industry and lead to a surge in an already fast-growing business.

How fast-growing is fast-growing? Worldwide legal cannabis sales totaled nearly $15 billion in 2019, according to data from ArcView Group, an investment research firm specializing in cannabis, and BDS Analytics. That's up from $10.2 billion the year before — a 46% boost.

If you're an investor, those numbers may have your mouth watering (or not, if it's, you know, a little dry). But before you get the munchies for pot stocks, take a minute to understand the challenges cannabis firms face and the how investors can responsibly enter a volatile segment of the market.

Cannabis investing: 'Not for the faint of heart'

It's been a bumpy ride for pot-stock investors in recent years. "Investing in cannabis is not for the faint of heart," says Vivien Azer, a managing director and senior research analyst at investment research firm Cowen. "These stocks can be incredibly volatile. Some of the names I cover are down 50% to 60% on the year."

Many of the cannabis stocks you may have heard of, such as Canopy Growth, Cronos Group, and Tilray, are major players in Canada, which legalized recreational marijuana nationwide in 2018. As the first legal operators in the world, many such firms set their sights on "global dominance," expanding operations too quickly and spreading themselves too thin, Azer says.

As a result, many Canadian cannabis players have posted disappointing earnings, causing the stocks to slide since the December legalization announcement. The ETFMG Alternative Harvest ETF (MJ), headlined by major Canadian growers, currently trades for about $12 per share, down from its peak price of $40 in September 2018.

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What this election means for the U.S. cannabis business

The U.S. is the biggest contributor to growth in the marijuana market, even though the drug is still illegal on the federal level. Americans accounted for $12.2 billion of the $14.9 billion in worldwide cannabis spending in 2019 and would likely make up the bulk of $42.7 billion in revenues ArcView Group projects for 2024.

But marijuana's status as an illegal drug creates major financial headaches for U.S. operators. Because of pot's status, U.S.-based marijuana firms can't secure funding from major financial institutions. Firms cannot transport product across state lines, meaning companies hoping to expand must set up operations in multiple states. And marijuana firms are expected to pay taxes, but as illegal businesses can't take normal business deductions.

"They effectively pay taxes on gross profits rather than pre-tax income," says Azer.

These stocks can be incredibly volatile.
Vivien Azer
Managing Director and senior research analyst, Cowen

Depending on the results of the election, some of that might change. Two pieces of legislation that have enjoyed some level of bipartisan support in Congress would allow cannabis firms to access banking and investing markets and would alleviate the burdensome tax situation. The banking issue may well be resolved regardless of the make-up of the next government, says Chris Lindsey, a legislative analyst at the Marijuana Policy Project.

Analysts at Cowen say key legislation has an 80% of passing within the first 12 months of a Biden presidency, given a Democratic majority in the Senate. They say it has a 20% chance of passing should the Senate majority stay red.

Total federal marijuana legalization is still a few years down the road at least, Lindsey says. "Simply removing it from the Controlled Substances Act wouldn't be enough. You'd have to develop a regulatory system that would be in effect for cannabis. It would then fall under the jurisdiction of the FDA. There are a lot of dots to connect," he says.

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How to invest in pot stocks

Even if voters in all five states reject legalization, and the Republicans hold on to the White House and a majority in the Senate, the marijuana industry in the U.S. still looks poised for growth, says Morgan Paxhia, co-founder and managing director of Poseidon Wealth Management, a cannabis-focused investing firm. "Even the status quo for our industry likely means 30% compounding annual growth for years to come," he says.

Investors looking to take advantage should tread carefully, he says: "Any early stage industry is going to be volatile. Some of the prominent names now will likely not be around in five years."

For investors willing to speculate, take the edge off the volatility by spreading your bets. Released in September, the AdvisorShares Pure US Cannabis ETF (MSOS) invests in a basket of the leading U.S. cannabis firms, many of them companies with operations in multiple states. Such firms generally enjoy healthier balance sheets, larger opportunities for expansion, and higher profitability than their Canadian counterparts and smaller U.S. firms, Azer says.

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