Marijuana Stocks a Bummer for Investors

Brian O'Connell

At first blush, the marijuana market may look appealing for early investors.

According to the 2016 Marijuana Business Factbook, the "U.S. cannabis industry will pump up to $44 billion annually into the country's economy by 2020, if current business and legalization trends continue." That's up from $17 billion in 2016, the Factbook states.

Industry insiders are positively bullish over pot's prospects for portfolio success.

"Our projections reflect marijuana's march towards the mainstream as it emerges from the shadows to become a respectable, above-board industry that is giving birth to scores of jobs, fostering new business opportunities and creating a broad ripple effect across the country," says Chris Walsh, managing editor of Marijuana Business Daily.

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"We're witnessing the emergence of a business that is about to become a massive economic force," he adds. "These figures, which we deem conservative, show not only how important the industry already is to the U.S economy at large, but also how much more important it is about to become."

Hazy outlook. Financial experts contacted by U.S. News & World Report say there are plenty of caveats when putting money into the marijuana market.

"We were heavy investors in the tobacco sector (as well as gaming, defense and alcoholic beverages) back in the day," says Allen Gillespie, a money manager at FinTrust Investment Advisors in Greenville, South Carolina, and one of the former managers at the Vice Fund. "For example, Philip Morris, specifically, was one of the largest taxpayers and highest returning stocks in the entire market for numerous decades."

In that regard, Gillespie sees cannabis as "the new tobacco" but with important considerations.

"Most vice sectors tend to be good investments, because they are protected by government licensing requirements, which fundamentally limit competition," Gillespie says.

Gillespie expects the industry to develop and expand, especially every time there is a recession, because states like tax revenues to move in a straight line. "But that doesn't happen during a recession, so they pass voluntary taxes," he says. "If there is ever federal clarity, then the tobacco players will get involved."

Not everyone sees marijuana as a wise investment, however.

"Investments in cannabis are not for the average investor," says Aaron Herzberg, partner at CalCann Holdings, a California-based medical marijuana real estate company with a portfolio of licensed medical marijuana holdings. "Cannabis remains federally illegal and there are significant challenges with federal taxation and lack of access to banking. Regulations are established on a state-by-state level and are constantly in flux."

Herzberg says that people think money grows on marijuana plants, but the reality is that the business is complex, capital intensive, and like any other real investment, requires patience and discipline.

"Those looking to make a quick buck out of marijuana are likely to fail," he says.

"Right now, there is quite the 'green rush' going on, as everyone tries to make sense of the investment opportunities in cannabis," says Jordan Tishler, Harvard University physician and expert in cannabis therapeutics. "But most investment opportunities are going to be quite bad."

A risky investment. Tishler sees two segments for would-be investors.

"First, look at products that uniquely meet a need," he says. "For example, there are too many bong equivalents on the market already. Avoid the better mousetrap unless it really is somehow clearly better. An example would be the CannaCloud vaporizer that delivers fully metered doses of cannabis vapor, which is important for careful treatment of patients. No other vaporizer can do that at present."

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Second, consider the investment horizon. "If you're looking for a short play, look at the exploding recreational market. Ten percent of Americans currently use cannabis," Tishler says.

"While that's a lot of people, understand that unlike what the pundits are saying, it is not likely that legalization will convert more people to consumers," he says. "So it's a capped market. Ultimately it will be saturated with competing products and services."

One area of opportunity is the medical market, which Tishler calls a solid "long play."

"Far more Americans are middle aged and elderly, and the population is only getting older and sicker," he says. "Treatment of both acute and chronic illness and/or chronic pain will present a market that will dwarf recreational usage."

John Torrens, a professor at Entrepreneurship Practice at Syracuse, and a board member at a cannabis company, is more skeptical.

"Cannabis is still a risky investment for a variety of reasons related to the fact that it's still illegal under federal law," Torrens says. "Even though the U.S. Department of Justice has directed law enforcement not to pursue cannabis businesses that operate within local and state regulations, the feds still use size as a proxy for illegal activity and have a tendency to harass large operations which would make the best investment opportunities."

Regulatory ambiguity is keeping a lot of professional money out of the industry, which creates room for smaller investors to establish a foothold, Torrens says.

"Plus, once federal regulators reschedule cannabis as a schedule two instead of a schedule one drug, then the doors will be open for professional and institutional money to pour in," he says. "This will be the big exit opportunity for the early investors."

When researching cannabis investment opportunities, Torrens says deciding whether you want to invest in a company that touches the plant (such as cultivation, extraction, manufacturing, dispensing or delivery) or one that sells into the industry, such as lights, greenhouses, nutrients and extraction equipment.

Here are some things Torrens suggests to look for before investing in pot stocks or funds:

Experience. Seek out an experienced team that not only knows how to grow and extract, but also knows the compliance landscape in their state. "Compliance needs to be a top concern," he says.

Licenses and permits. "This is especially true in California where some municipalities have very loose regulations," Torrens says. "This creates an opening for the feds to come in and shut it down."

Distribution. Even if you can grow the best cannabis out there, if the team doesn't have the relationships inside the industry to sell it, then you may as well have invested in a Nasdaq company. "The market demand exists, but in an industry that is just coming out of the shadows, the strength of relationships is critical," he says.

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Go slow. "If you think you want to play in this space, then start with a small, manageable investment," Torrens says.

Brian O'Connell is a Bucks County, Pennsylvania, business writer and author. A former Wall Street bond trader, O'Connell is the author of two best-selling books, and is a frequent contributor to TheStreet.com, CBS News, Bloomberg and other major media business platforms.