10 Reasons Not to Invest in Marijuana Stocks

You’re going to invest in cannabis. Remember that investing in cannabis is risky business. Many people who invested years ago got the jitters, sold their shares, and lost a lot of money. Some people lost money to con artists or well-intentioned friends or family members. Others lost out because they invested in cannabis businesses that didn’t make it.

However, as long as you’re well aware of the risks, if you decide to move forward, I applaud your bold initiative, and I hope you receive ample compensation for your risk-taking. People like you are the ones who drive innovation and fuel the success of new industries such as cannabis.

Still, I’m going to take this opportunity to caution you in the hopes that the risks persuade you to tread carefully — to do your homework and perform your due diligence. Savvy investors stand to earn handsome returns on their investments as long as they make smart investments. Those who rush in and are clueless and careless will lose their shirts.

Following are 10 reasons for not investing in cannabis. Keep these reasons in mind as you seek your fortune in the green rush.

Marijuana is still federally illegal in the United States

Although momentum seems in favor of federal legalization of marijuana sometime in the future, nobody has a crystal ball that can tell them for sure what will happen. A new study might come out revealing some currently unknown harmful effect that makes legislators who are already against legalization dig in their heels. Or, some other unforeseen event or change in culture or beliefs could cause voters to become less accepting of marijuana use. Who knows?

Until marijuana is federally legal, the federal laws against it will restrict growth in the industry in several ways, including the following:

• Increase the cost of doing business
• Continue to fuel the black market for cannabis
• Complicate and increase the cost of expanding businesses across state lines and into foreign markets
• Make banking and other financial services less available for cannabis businesses

When you invest in cannabis, to a certain degree, you’re betting that it will ultimately become legal on a federal level. I believe that will happen, eventually, but it’s not a sure thing, and even if it were, nobody knows when it will happen.

Marijuana investment scams are rampant

Con artists profit on the human desire to have a better life. Some would call that greed, but I really think most people just want to have enough money to pursue their dreams. Many people see cannabis as the next gold rush. In fact, the recent boom in legal cannabis companies has been described as a “green rush.” Everyone wants to get in on the action and not to miss out on the opportunity to profit from this exciting new industry. And that’s exactly what makes people vulnerable to scams — that and the fact that people generally trust others.

Con artists know that people are eager to invest in cannabis, so whenever someone expresses this eagerness, they become a target. Of course, the threat of a scam isn’t reason enough to avoid investing in cannabis, but it is a good reason to remain skeptical of opportunities that seem too good to be true.

Earning a profit as a cannabis business is a huge challenge

As an investor, you’re wise to invest in profitable businesses or at least those that have a good chance of being highly profitable. Unfortunately, cannabis is a heavily taxed and regulated industry, which increases the costs and complexities of doing business. It’s not like selling bottled water. Here are a few line items that take a huge bite out of cannabis business profits:

• Taxes. Cannabis businesses are prohibited from claiming business deductions on their federal taxes. Also, the high sales and excise taxes on cannabis products reduce demand and steer sales to the black market.
• Application and licensing fees. Application and licensing fees for legitimate cannabis businesses can be exorbitant in some states; for example, Connecticut charges a $25,000 application fee and a cultivation licensing fee of $75,000. In addition, businesses often must hire a lawyer to navigate the process.
• Capital requirements. Many states require cannabis businesses to hold a certain minimum in liquid assets (typically hundreds of thousands of dollars) to obtain and keep their license.
• Compliance costs. Companies often incur high legal costs and must purchase specialized software to remain compliant because most states require tracking cannabis “from seed to sale.”

I could go on, but the point is that earning a profit in cannabis isn’t easy, and until it becomes easier, cannabis businesses will have a tough time proving their value to investors.

Illegal operations undermine demand for legal products

In many areas where cannabis is legal, the black market continues to thrive because 1) cannabis is often cheaper on the black market where businesses don’t pay taxes or application and licensing fees and don’t incur the costs of attorneys and compliance, and 2) the cannabis community is sort of anti-establishment, so many consumers prefer to buy from unlicensed growers and dealers.

In addition, in many states in which cannabis is legal, people are allowed to grow a certain number of cannabis plants of their own. They need to buy seeds, fertilizer, and maybe the equipment to set up a grow room, which gives suppliers of those items additional business, but it decreases demand from commercial growers, manufacturers, and dispensaries.

The industry is very fragmented

The cannabis industry consists mostly of small businesses competing against one another, which means businesses will come and go. Some will fail, and some will succeed. Eventually, as cannabis legalization grows, large national companies will step in and either buy up competing companies or drive them out of business. People who invest in cannabis now, when the industry is fragmented, are likely to experience losses as some of the companies they “bet on” fall to the competition.

The take-home message here is that if you’re accustomed to trading in companies listed on the major stock exchanges, such as the NYSE and Nasdaq, now may not be the best time to invest in cannabis. You may want to wait until the industry starts to consolidate; then, you’ll have an easier time predicting winners and losers.

Oversupply is more likely than not

Many states in which cannabis is legal face problems with oversupply — too many growers growing more cannabis than the consumers in the state want or need. Oversupply drives down prices and profits and makes companies less attractive to investors.

Oversupply is another problem that’s at least partially due to the fact that cannabis is illegal on a federal level. If cannabis were legal federally, or if growers could at least ship their products over state lines, they’d have a larger market in which to sell and compete. As it is now, states must deal with the problem of oversupply internally, which usually means issuing fewer licenses to cultivators or charging significantly more for applications and licenses.

Bad news is just around the corner

To a large degree, rumors and news drive the stock market. In fact, some investment gurus advise to “buy on the rumor and sell on the news.” With cannabis, the opportunity for bad news is pretty high. In 2018, good news (mostly a combination of hype and hope) drove share prices in cannabis companies sky high. Shortly thereafter, the bad news (mostly poor earnings reports from some of the major players) led to a massive selloff.

This boom-to-bust cycle is likely to continue because hype and hope continue to motivate investors in this industry. In addition, because cannabis is a drug, both good news about its benefits and bad news about its side effects are likely to contribute to the volatility.

There is money to be made by investing in cannabis, but I urge you to invest with your head and not your heart. Carefully research each company’s fundamentals and be sure the share price is supported by those fundamentals.

Marijuana laws are slow to change

As long as marijuana remains illegal at the federal level, many states are going to drag their feet over legalization, and local jurisdictions are going to use the federal law as an excuse to pass their own restrictions on its sale and use. When the federal prohibition of marijuana will end is anybody’s guess. I think it’s likely to happen the next time the Democrats control the White House and Congress, which might happen before this book is published, four years later, or maybe even a much longer time from now.

Company shares are being diluted

Companies can secure financing through debt (borrowing) or equity (selling shares in the company), which is true of all companies. What’s different about cannabis companies is that they have trouble securing loans from banks, so they have to rely more on equity. When they get in a financial pinch, if they can’t get a loan, they need to sell more shares, and the more shares they sell, the more diluted the price of existing shares becomes. Unfortunately, investors have little control over decisions to issue more shares, even though that decision impacts the value of their investment.

Shares can be diluted in any sector, any industry, and any company, but the possibility is higher among cannabis companies.

Demand is unpredictable

Several states that have legalized marijuana are finding that demand can be unpredictable for a variety of reasons, including the following:

• Cross-border sales may increase demand for marijuana in legal states surrounded by illegal states. However, when bordering states legalize it, cross-border sales decline.
• Any black-market sales reduce demand for legal cannabis.
• Any bad news about negative side effects reduces demand, although the drop in demand is usually short-lived.

Whether demand for cannabis will increase or decrease with its legalization is hotly debated. I think demand is almost certain to rise with legalization, but others think it could fall as marijuana loses its appeal as a “forbidden fruit.”