The cannabis sector is slowly recovering from its long period of prohibition and the investment opportunities are exciting. Retail investors consider in the longer term of the industry and wish to be a part of it before regulations change. The institutions covering the sector are keeping an in depth eye on this, although most haven’t yet embraced it.
The cannabis industry represents a brand new frontier for investment and offers quite a few growth opportunities. The hype and speculative boom of 2018 and early 2021 has subsided and the market is right-sized: Valuations are more reflective of actual profitability, as cannabis firms suffer from the identical lack of capital as other areas of the private markets, even in the event that they are more within the USA are states legalizing cannabis consumption.
So how did we get here?
This is not the primary time U.S. consumers have had access to legal weed. In colonial times, governments promoted cannabis cultivation. The Virginia Assembly required farmers to grow hemp, a non-psychoactive strain of cannabis used to make sails, rope and other textiles. The plant was grown by, amongst others, George Washington and Thomas Jefferson. Until the late nineteenth century, consumers could purchase psychoactive cannabis at their local pharmacy.
The U.S. government made its first foray into this otherwise free market in 1906 when it required cannabis-infused products to be labeled as such. However, the true change within the perception and regulation of cannabis got here with the Marijuana Tax Act of 1937, which ushered within the era of Reefer Madness. Led by Harry Anslinger, commissioner of the Federal Bureau of Narcotics (FBN), a forerunner of the Drug Enforcement Agency (DEA), the law aimed to criminalize the sale and possession of cannabis. Over the years, cannabis became related to the countercultural movements and anti-war protests of the Nineteen Fifties, Sixties and Nineteen Seventies, and latest laws imposed increasingly harsh penalties.
But in recent many years, amid a slow shift in sentiment, the pendulum began to swing back, and the ban gave method to toleration, if not acceptance, before Anslinger. California was the primary state to legalize medical cannabis in 1996, and Colorado and Washington were the primary to legalize recreational use in 2012. Today, recreational cannabis is legal in 23 states and its medical use in lots of more. However, psychoactive cannabis stays illegal on the federal level.
Today’s fragmented landscape
But the more states legalize cannabis, the more Americans support federal legalization. Young people drink less alcohol and use more marijuana. The stigma related to cannabis use has disappeared. The marketplace for cannabis wellness products has great growth potential amongst older cohorts.
The federal government cleared a serious hurdle here last 12 months. It lifted the ban on federal funding of medical cannabis research and allowed doctors to check with their patients about cannabis. Nevertheless, cannabis as a drug stays the best risk classification alongside heroin, LSD and ecstasy and is taken into account medically unproven. According to those reviews, cocaine, methamphetamine and fentanyl pose a lower risk of abuse than cannabis. With more research into its medical advantages and a lower potential for abuse, pressure to reclassify cannabis will increase.
Investments in cannabis include not only firms that touch plants – growers, edibles and joint manufacturers, and dispensaries – but in addition firms that provide services to cannabis firms, from technology to fertilizers. Businesses that come into contact with plants are subject to the federal government’s cannabis tax penalty structure. Because cannabis remains to be classified as an illegal substance, cannabis firms can only deduct their expenses for cost of products sold (COGS). This results in a high effective tax rate, which hits pharmacies particularly hard with their high personnel costs.
This is why investors are so excited concerning the prospect of federal legalization and exemption from this tax treatment. But their optimism might be misplaced: they shouldn’t hold their breath. Much of the investment capital within the cannabis space continues to flow to non-plant-related firms. This approach of selling shovels to gold miners is clearly attractive. Companies can avoid penalty taxes and potentially achieve greater profitability with less legal risk.
Where is the cash?
Because it is illegitimate on the federal level, cannabis can’t be transported across state lines, nor can associated capital be transferred through the federal economic system. In practice, which means that each state has its own microcosm of brands, products, crop types and financial arrangements. The landscape for cannabis investors in Arkansas looks very different than in California.
This ecosystem of small players in small markets exists parallel to that of the so-called multi-state operators. Such organizations establish individual businesses in several states under the identical name, allowing them to say a cohesive operation in multiple states, despite the fact that they will only sell their goods within the state where they were grown and manufactured.
Multistate operators have attracted the majority of the associated investment capital. Their rankings skyrocketed amid social isolation related to the COVID-19 pandemic, the accompanying rise in recreational drug use and anticipation of possible federal legalization under a brand new Democratic administration.
Needless to say, the hype in 2021 was just that – a green rush – and cannabis valuations soon got here crashing back all the way down to earth. The historical prices of MSOS, the primary cannabis-focused exchange traded fund (ETF) within the US, reflect this development.
Performance of the AdvisorShares US Pure Cannabis ETF (MSOS).
September 2, 2020 to October 18, 2023
Source: Bloomberg
Multi-state operators are actually specializing in consolidation and value reduction. Smaller operators either find their competitive niches or close down. And a gaggle of burned investors are vowing never to place money into cannabis. In other words, there’s a number of blood on the streets of the cannabis industry. Many cannabis-focused investment shops opened throughout the bubble, when investors threw their money at anything that smelled like marijuana. Some have lost greater than 60% of their original value and have conjured cannabis market benchmarks to rationalize this massive wealth destruction.
Although it’s far more difficult to lift money for cannabis investments today, investors are still fascinated with the opportunities presented by this emerging industry. Without reliable benchmarks or historical averages to guide future performance expectations, these investors will inevitably come to different and varied conclusions.
Still, despite the dual risks of unfavorable tax treatment and overly optimistic expectations of federal legalization, the cannabis sector is what nostalgic investors who remember the bond markets of the Nineteen Eighties crave: an inefficient market in need of thorough fair value evaluation pays out.
The industry can bring about so far more than simply giggles and cravings. Research into the non-psychoactive components of the plant remains to be in its infancy, but is progressing rapidly. In fact, cannabis products could have potential applications in promoting gut health and treating cancer, chronic pain and mental illness, amongst other things, and the pharmaceutical industry has taken note.
In addition, the investment opportunities extend far beyond the USA. Many foreign governments either encourage their cannabis industries or not less than don’t hinder them. While the U.S. market could have the best growth potential, its international counterparts are growing for each medical and recreational purposes, and plenty of developing countries have lower production costs and more favorable growth climates.
The public perception of cannabis has undergone a dramatic evolution, from a crop grown by the Founding Fathers, through the era of marijuana madness, criminalization, and cannabis as an emblem of countercultural riot, to gradual legalization within the twenty first century. Investors fascinated with an emerging sector with an uncertain but potentially lucrative future should listen.
Photo credit: ©Getty Images / underworld111
