The 5 Worst Reasons to Buy Marijuana Stocks

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Chances are you'd struggle to find an industry that's been stronger over the trailing one-year period than legal marijuana. Cannabis research firm ArcView pegged North American legal weed growth at 34% in 2016 and foresees a compound annual growth rate of 26% over the coming five-year period.  Not surprisingly, marijuana stocks have jumped, as an aggregate, by an average of more than 100% over the trailing year, if we only consider the 14 with a current market cap above $200 million.

Aside from the massive sales growth behind pot stocks, changing public perceptions have played a key role. No longer perceived to be on the same level as heroin, LSD, and other Schedule I substances, some 60% of respondents want to see marijuana legalized across the U.S., according to Gallup's October 2016 poll. This represents an all-time record high, and it suggests that pressure could be mounting on Congress to make changes in their scheduling of cannabis at the federal level.

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However, rapid sales growth and changing perceptions have also attracted a sea of speculators who've thrown around a number of bad reasons to buy into the budding weed industry. If any of the following five reasons summarize why you've purchased a marijuana stock, or a group of stocks, it may be time to re-evaluate your holdings.

1. "The U.S. government has to legalize"

The thesis here is pretty simple: The percentage of folks who want to see marijuana legalized in some form is skyrocketing, meaning Congress and state governments will have no choice but to listen to the will of the people and legalize cannabis, or risk being voted out of office. In addition to the 60% of Gallup respondents who want to legalize recreational weed, 94% in a Quinnipiac University poll want medical cannabis to be legal nationally. Sounds like a valid thesis, right?

There's just one big problem: Congress doesn't have to do anything. Not to deny the fact that Americans have dramatically shifted their views on pot over the past two decades, but it seems highly unlikely that a single issue like marijuana is going to be the reason incumbents are voted out of office if they don't alter their stance on weed. At the moment, Congress is far too concerned with healthcare and tax reform, the debt ceiling, and the upcoming budget to even remotely consider federal marijuana legislation.

2. "It's legal in more than half of all U.S. states"

Another common investment thesis in marijuana stocks is that expansion via state approvals should lead to growth. Right now, 29 states have legalized medical cannabis, leaving just 21 that haven't, and eight states have legalized the sale of adult-use weed to those aged 21 and over. With more than half of all U.S. states having legalized, marijuana stocks have to be a great investment, right?

Not exactly. Quite a few of the remaining 21 states that haven't legalized medical cannabis are run by Republicans, who are among the two groups, along with senior citizens, who still oppose the expansion of marijuana.

Also, 24 U.S. states lack the initiative and referendum process, meaning legislation at the state level is essentially the only way to pass medical and recreational pot laws, leaving residents with very little say in the matter. Earlier this year, Vermont's state legislature passed a bill to legalize recreational cannabis and become the ninth state to do so, but Gov. Phil Scott (R-Vt.) vetoed the measure. Long story short, expansion opportunities appear to be dwindling, not increasing, in the United States.

3. "The growth rate for marijuana is off the charts"

Some speculators turn to the eye-popping growth rates behind legal weed as a reason to invest. As noted, ArcView sees legal marijuana sales in North America growing by 26% annually through 2021, reaching nearly $22 billion by that time. With some of the fastest growth estimates around, marijuana stocks have to succeed, right?

Wrong. One of the biggest issues with the marijuana industry being so new is that we haven't seen much in the way of industry consolidation. It means that smaller mom and pop-type dispensaries and even grow farms are competing against one another. Without industry consolidation, it makes it incredibly difficult for the retail investor to profit from the growth of legal weed.

What's more, marijuana's Schedule I categorization leads to a host of disadvantages for businesses that include an inability to take normal corporate income-tax deductions, as well as difficulty in securing basic banking services, even for something as simple as a checking account. Researchers also struggle to get the green light to run critical clinical studies into the benefits and risks of medical cannabis.

4. "Marijuana is medicine"

Another clear argument in favor of investing in marijuana stocks -- especially those that are developing cannabinoids to fight disease, or are utilizing the body's natural cannabinoid receptor system -- is the idea that marijuana is medicine. With 29 states having legalized cannabis for medicinal purposes, investors see its benefits outweighing its risks and therefore generating a lot of money for pot stocks. Solid thesis, right?

On one hand, we have the example of GW Pharmaceuticals (NASDAQ: GWPH), which dazzled in multiple phase 3 trials with oral cannabidiol drug Epidiolex as a treatment for two rare types of childhood-onset epilepsy. In all instances, Epidiolex led to a statistically significant reduction in seizure frequency, setting the drug up for what could be a 2018 approval from the Food and Drug Administration.

However, there's been no shortage of cannabinoid-based failures, either. GW Pharmaceuticals' Sativex failed miserably as a treatment for cancer pain in U.S. phase 3 trials, while Zynerba Pharmaceuticals (NASDAQ: ZYNE) recently disappointed in two studies involving its cannabidiol-based gel, ZYN002. Zynerba's lead drug failed to produce a statistically significant reduction in focal seizures for epileptic patients in the Star 1 study, while the Stop trial for patients with osteoarthritis of the knee also missed its primary endpoint. At least the Stop study hit a few secondary endpoints, offering some glimmers of hope.

Long story short, cannabis may be medicine, but it's not a miracle cure by any means based on this clinical data.

5. "I'm a marijuana user, so buying pot stocks makes sense"

Lastly, some folks might be buying into marijuana stocks simply for the sake of sticking with what they known. In other words, marijuana users, be it medical or recreational, are buying into marijuana stocks because they're familiar with the product, much in the same way you could buy Coca-Cola stock because you drink Coke. Buying what you know is a great investment thesis, right?

Generally speaking, yes it is, as long as the product has staying power. But there's no guarantee that the weed industry has any staying power, for two key reasons. To begin with, in case you forgot, cannabis is still wholly illegal at the federal level. "Buy what you know" doesn't work very well when the federal government outlaws what you're investing in.

The other issue here is Attorney General Jeff Sessions, who'll seemingly stop at nothing to ensure that marijuana's scheduling at the federal level isn't changed. In short, pot is likely to remain a Schedule I drug throughout the Trump presidency, severely hampering the "buy what you know" thesis.

For marijuana stocks to be investment-worthy, we're going to need to see clear changes at the federal level and industrywide consolidation. For the time being, the safest place continues to be on the sidelines.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.