The legal=cannabis industry is on fire, and we only need to look as far as marijuana stocks for verification. Over the trailing one-year period, more than half of all pot stocks with a valuation in excess of $200 million have at least doubled in value.
Marijuana has investors seeing green
Continue Reading Below
Why are investors flocking to marijuana stocks? To begin with, Americans' perception of marijuana has shifted dramatically over the past two decades. In the mid-1990s, the War on Drugs was still ongoing, and just a quarter of the public wanted to see marijuana legalized on a national scale. However, since California became the first state to legalize medical cannabis for compassionate use in 1996, 28 other states have followed suit. We've also seen eight states legalize recreational, adult-use weed since 2012. According to Gallup, as of 2016, some 60% of respondents now favor legalizing marijuana nationwide. Pot proponents believe expansion is more likely, given that politicians who oppose cannabis threaten to be voted out of office if they don't change their views on the drug.
Select states have also advocated for legalization because of the revenue it could bring in. California is actually a great example. The passage of Proposition 64 (which legalized recreational pot) in the November 2016 election opens the door for California to collect around $1 billion in additional tax revenue each year. California is a state whose budget commonly comes up short on cash, so this tax revenue could be sorely needed.
Legal-marijuana sales growth is a third catalyst that's really catapulted marijuana stocks. According to cannabis research firm ArcView, North American weed sales grew by 34% in 2016 to $6.9 billion, and they're on pace to grow by an estimated 26% per year through 2021. It's very easy for investors to get excited about a 26% compound annual growth rate.
A low ceiling on the marijuana industry
But the marijuana industry continues to deal with a number of setbacks, and No. 1 on that list is the U.S. federal government, which has chosen to dig in its heels and keep marijuana as a Schedule I substance. As a Schedule I drug, cannabis has no recognized medical benefits and is deemed wholly illegal, right alongside LSD and heroin.
The disadvantages the marijuana industry faces are plenty. For starters, it's exceptionally difficult for medical-cannabis researchers to run sanctioned risk-versus-benefit studies since the drug has such a restrictive scheduling. Without these studies, it's going to be very difficult to convince lawmakers on Capitol Hill that medical marijuana offers benefits to patients.
Furthermore, pot-based businesses are unable to take corporate income-tax deductions since they're selling a federally illegal substance. This means paying far more income tax than a "normal" business, assuming it's profitable in the first place.
Marijuana companies also have a difficult time gaining access to basic financial services. Financial institutions report to the Federal Deposit Insurance Corporation (FDIC), and since the FDIC is a federally created entity, and marijuana is illegal at the federal level, banks generally want nothing to do with cannabis businesses for fear of criminal prosecution or fines. That means virtually no access to loans, lines of credit, or even something as simple as a checking account. And as you may have rightly guessed, dealing solely in cash is a security concern and a growth inhibitor for the industry.
How does legalizing marijuana across the country sound?
These inherent disadvantages are enough to drive some in Washington to action.
Earlier this month, Sen. Cory Booker (D-NJ) introduced arguably the most progressive marijuana bill to have ever been put forth in Washington: the Marijuana Justice Act of 2017. The Marijuana Justice Act wouldn't just alter the scheduling of marijuana; it would de-schedule it completely at the federal level.
What's more, Booker's bill seeks to encourage other states to legalize cannabis locally or otherwise face possible penalties. In particular, the bill would withhold federal funding for the construction of jails and prisons in states where cannabis laws have been shown to have disproportionately incarcerated minorities. Up to 10% of other federal funding could be withheld as well in these states. Also, federal convictions for marijuana use and possession would be expunged, and prisoners still serving time for a marijuana offense would be entitled to a sentencing hearing.
And that's not all.
The Marijuana Justice Act also sets up a Community Reinvestment Fund that would reinvest in communities affected by the War on Drugs, and it allows those affected by the disproportionate arrest rate to sue.
Booker's bill would be a clean slate for the marijuana industry, and it would potentially pave the way for an immediate boost in sales and production.
Dead on arrival
However, the bill has virtually zero chance of passing in the Republican-controlled Congress.
As Gallup noted last year, just two groups of people continue to oppose marijuana's expansion: senior citizens and Republicans. And, surprise, you get both in Washington. In fact, now-former White House press secretary Sean Spicer intimated in February that the current administration would look to more forcefully regulate the marijuana industry relative to the Obama administration. That's potentially bad news for marijuana stocks and the industry as whole.
There's also Attorney General Jeff Sessions, who might just be the biggest opponent of marijuana's expansion in the country. In May, Sessions sent a letter to Congress requesting that it repeal the Rohrabacher-Farr Amendment, which disallows the use of federal funds to go after lawfully operating cannabis businesses in states where cannabis is legal. In other words, Sessions really wants to trample states' rights and go after medical-marijuana businesses.
Unless support for marijuana pushes considerably higher among the public, and Americans move forward with threats to vote politicians not in favor of cannabis' expansion out of office, the chances of major reform occurring during the Trump administration is very, very low.
For marijuana stock investors, it means one thing: Keep your industry exposure limited, because the industry's future isn't guaranteed. My suggestion would be to consider a company like Scotts Miracle-Gro (NYSE: SMG), whose focus on the marijuana industry represents only around 10% of its revenue. Scotts is first and foremost a lawn and garden care company, and it'll remain so for the foreseeable future. Investors can take advantage of growth from its subsidiary, Hawthorne Gardening Co., in hydroponics (growth conducted in a soilless, water-based nutrient-rich solution), as well as lighting and nutrients for the medical-pot industry. Even if the weed industry struggles, Scotts can fall back on its century-old lawn and garden care business, which means your downside is limited.
10 stocks we like better than Scotts Miracle-GroWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Scotts Miracle-Gro wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 1, 2017