How Big Could the Opportunity Be for Marijuana Stocks in California?

By Todd Campbell Markets Fool.com

In November, Californians overwhelmingly voted to embrace pro-pot laws that clear the way toward creating the United States' biggest recreational marijuana market. Is California's marijuana market a boon to marijuana investors? Read on to see how big California's marijuana market could become.

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Image source: Getty Images.

First, some history

California pioneered medical marijuana legalization in the 1990s, but it has been slower to endorse laws that open up the recreational marijuana market.

In 2010, California's Proposition 19 fell on deaf ears when 53.5% of voters opted against passing it. If it had been passed, Proposition 19 would've allowed Californian adults over age 21 to possess up to 1 ounce of marijuana for personal consumption, and to grow marijuana in a space of up to 25 square feet.

At the time, supporters applauded Proposition 19 for its potential to help end the drug war with Mexico, while generating significant tax revenue. At least one report suggested that if passed, Proposition 19 could've saved $200 million on law enforcement expenses and added $1.2 billion annually in tax revenue.

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Despite those arguments, the opposition was able to convince the majority of voters that those savings and tax receipts were overstated.

Getting it done

The recreational market has changed significantly since Proposition 19's failure in 2010. Colorado and Washington passed recreational marijuana laws in 2012, and they were joined in 2014 by Oregon and Alaska.

So far, legalization in those states has been a success, particularly in terms of increasing tax revenue.

For example, marijuana sales eclipsed $1 billion in Colorado last year, and the state reports it collected $17.7 million in marijuana taxes, fees, and licenses in November 2016 alone.

With other states having taken the lead on passing recreational marijuana laws, and support for legalization growing nationally, pro-pot advocates faced a less rocky road to victory this past November.

Overall, the Adult Use of Marijuana Act, or Proposition 64, passed by a vote of 57.13% for and 42.87% against, and that means that Californians can now possess up to 28.5 grams of marijuana, and grow up to six plants.

The law also sets up a process for licensing dispensaries that can sell marijuana and marijuana products, and it gives California the right to charge fees and collect taxes on marijuana.

Overall, California's established medical marijuana production and distribution infrastructure should allow for a quick ramp in recreational marijuana revenue. California's Emerald Triangle region is considered to be the largest area for cannabis production in the United States, and there are already more than 900 medical marijuana dispensaries operating in the state.

That has Matt Karnes, founder of GreenWave Advisors, LLC, estimating that the state's marijuana market could climb from about $2.8 billion in 2017 to $5.8 billion in 2018, when the recreational market is fully up and running.Karnes also predicts that California's recreational marijuana market will mature rapidly, increasing to $7.7 billion in 2021.

Investing in marijuana stocks

The potential for a more than doubling in marijuana sales in California over the next five years has many investors hunting for stocks that could benefit from it.

Unfortunately, the marijuana market remains dominated by small players with limited market share, and as a result, most publicly traded marijuana stocks trade on unregulated over-the-counter markets that are ripe for fraud. Additionally, because these companies are reinvesting heavily into their businesses, many of these companies are unprofitable.

Investors also have to be careful because the industry faces risks associated with uncertainty at the federal level. Nationally, marijuana remains illegal, and the nomination of legalization opponent Jeff Sessions as attorney general does little to assuage fear of a federal crackdown.

As a result, those who are interested in investing marijuana stocks are left with few choices. They can invest in Canadian marijuana stocks that also trade in the U.S., or they can invest in drug companies attempting to develop treatments that are derived from cannabis' chemical cannabinoids.

Canopy Growth Corp (TSX: CGC) (NASDAQOTH: TWMJF) and Aphria, Inc. (NASDAQOTH: APHQF)are two Canadian companies worthy of consideration; however, both companies are investing heavily in their businesses, and thus, could have uneven profit growth over the coming years. They're also richly valued by investors already.

For example, Canopy Growth is a leader in Canada's medical marijuana market, and it has inked a marketing deal with marijuana icon Snoop Dog that could help accelerate sales. But, revenue remains less than$10 million per quarter, and its market cap is already near $1 billion.

Aphria's story is similar. The company's knee-deep in expanding production, but it only earned $0.01 Canadian per share last quarter on just CA$4.4 million in sales. Yet, it's being valued at roughly a half billion dollars.

Shifting gears, GW Pharmaceuticals (NASDAQ: GWPH) and Insys Therapeutics (NASDAQ: INSY)are two of the most investment-worthy marijuana drugmakers, but only GW Pharmaceuticals shares may make sense to buy right now.

Last year, results from three trials of GW Pharmaceuticals' purified cannabidiol (CBD), Epidiolex, showed it can reduce monthly seizures in patients with tough-to-treat forms of epilepsy by about 40%. Following those results, GW Pharmaceuticals plans to file Epidiolex for FDA approval this year. If the FDA approves it, Epidiolex could become a nine-figure top-seller someday.

Insys Therapeutics' story is less compelling. While Insys won FDA approval to market a new formulation of the long-standing THC drug Marinol in 2016, it has yet to receive DEA scheduling for the drug. Furthermore, Insys Therapeutics' management is embroiled in a long investigation of potentially illegal sales and marketing practices for its opioid spray, Subsys. Until those investigations wrap up, Insys Therapeutics is a high-risk stock to buy.

Overall, California's approval of recreational marijuana should provide significant new opportunities for marijuana companies, but this market is in the very early innings, and that makes investing in it quite risky.

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Todd Campbell has no position in any stocks mentioned.Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned.Like this article? Follow him onTwitter where he goes by the handle@ebcapitalto see more articles like this.The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.