A Business That Grew by 1000%: How Much Can You Earn Investing in Legal Medical Cannabis?
Six years ago, Isaac Becker wrote in Forbes about the emerging market for medical cannabis. In his new book, dedicated to various private investment strategies, he analyzes his experience investing in this market and discusses which of his predictions came true. With permission from Alpina Publisher, we are publishing a chapter from the book.
Pioneering Investment Ideas
“Pioneering” ideas (as the author calls investments in emerging or promising business areas where the market is not yet formed) come to investors in different ways. It’s hard to say exactly how it happens—people watch, read, follow the news, and at some point, realize there’s an opportunity to make money. This doesn’t always lead to success—there are big risks, but if you get lucky, the returns can be huge. For those willing to take the risk and interested in the “pioneer” strategy, I’ll describe two cases from my own experience in this and the next section.
Let’s start with how I invested in cannabis. I managed to enter this nascent market at the right time and made good money in 2013 and early 2014. I wrote about my experience in Forbes, which was probably one of the first articles on this topic in the Russian press.
That Forbes article mentioned four companies operating in the new market: British GW Pharmaceuticals Plc., American GrowLife Inc., Medbox, and mCig, which specializes in electronic cigarettes with cannabinoids. I want to emphasize that I am categorically opposed to narcotics and condemn the recreational use of cannabis. This article contains information about the investment characteristics of the legal business of producing medical products containing cannabis in certain countries, and related industries (author’s note for Forbes).
The Rapid Growth of the Medical Cannabis Industry
Before discussing the fate of the stocks mentioned in the article, it’s worth noting that over the past five years, the cannabis industry—cultivation and production of medicines—has developed at an astonishing pace. The first use of medical cannabis dates back to 1996 in California, and the first country to officially legalize it was Uruguay in 2013. As of early 2019, cannabis is partially legal in 30 countries, medical cannabis is legal in 14, and in the U.S., medical cannabis is legal in 33 states.
There is even discussion about full legalization in the U.S., as happened in Canada on October 7, 2018. To give you an idea of the scale, Statista reports that in 2018, $4.5 billion worth of medical cannabis was purchased in the U.S. About 28,000 companies are involved in this business in the States in one way or another.
What Happened to the Companies?
Let’s look at what happened over the five years after the article was written. First, one of the companies, Medbox, ceased to exist. All four companies brought investors hundreds of percent in returns in 2013–2014, but regulators accused Medbox of misleading investors about the scale of its business. The company was acquired and now operates under a different name, so it’s no longer of interest to us.
Of the three remaining players, one performed very well. Not only did its stock perform well over five years, but it also became the fourth largest company by market cap among cannabis-related businesses: $5.2 billion as of June 2019. This is GW Pharmaceuticals, whose shares grew by 83.4% over five years. While not as explosive as in the early days, it’s still impressive for a pharmaceutical company. The other two—GrowLife and mCig—lost about 90% of their value.
Key Takeaways and Risks
Why such different results? First, they illustrate the risks and peculiarities of “pioneer” strategies. Second, when a boom starts in a market, many speculative players rush in, hoping to make quick money. As a result, stocks in such promising markets are often highly overvalued, regardless of whether the companies are solid or just lucky beneficiaries. Private investors buy everything, paying little attention to financial results.
At the initial stage, the “pioneer” strategy worked—we had a successful 2013 and early 2014, largely because Uruguay became the first country to legalize cannabis. People sensed the trend and money poured in. The business was just starting, and entry was relatively cheap. GrowLife, for example, was a regular gardening company that quickly pivoted to cannabis. But over the long term, not everyone survived, leading to such varied results.
Another feature of the “pioneer” strategy is the need for diversification. You have to monitor the market and never cling to the early leaders. Over the past five years, new players with billion-dollar market caps have emerged. Here are a few examples: Canopy Growth Corporation ($14.4 billion), Aurora Cannabis ($10.3 billion), Cronos Group ($5.3 billion).
Industry Leaders and Market Potential
What do the top three companies in cannabis cultivation and processing for medicine have in common? They’re all Canadian. Canada is now the industry leader, thanks to the discussion and adoption of the cannabis legalization law. Looking at the data, it’s clear the industry’s potential is far from exhausted, and in my opinion, growth is still ahead, though natural corrections are possible.
In recent years, industry leaders have gained between 370% and 1122%. Such results are rare and show that cannabis remains a “pioneer” strategy. But it’s risky and requires careful, thoughtful investment—otherwise, you could end up with huge profits or massive losses.
Legal and Market Challenges
The main consumer of medical cannabis is the U.S. But it’s hard for such companies to enter the American stock market: cannabis is federally prohibited. Only the largest and strongest companies make it to the exchange, so most cannabis stocks are traded in Canada. Federal legalization in the U.S. could trigger a surge in industry stock prices.
The industry is growing not only through medical use but also by adding cannabis to traditional products. Beverage and confectionery companies are ready to use cannabinoids in their products. For example, brewing giant Heineken (HEINY), with a market cap over $50 billion, already produces a sparkling drink with small amounts of cannabis extract. And this is just the beginning.
New Business Opportunities
Potential investors should note that, as the industry develops, it creates new businesses around it. Some companies grow cannabis and compete on quality, others supply seeds, fertilizers, and equipment. There are firms that find locations for production and trade land. Tech companies develop software for tracking, logistics, and sales. And, of course, pharmaceutical companies play a key role.
In the U.S., the fastest-growing segment of cannabis consumers is people over 65, who often suffer from joint pain, insomnia, and other issues where medical cannabis products are effective. As the population ages, the number of medical cannabis consumers will grow. However, despite the market’s bright future, risks here are much higher than in traditional industries and established large companies.
Investing Through Cannabis ETFs
As in other sectors, there are exchange-traded funds (ETFs) focused on the cannabis industry. Currently, only three such funds are traded on the U.S. stock market—out of thousands of companies worldwide. The main reason is legal restrictions. Still, I’m sure that by the time you read this, there may be five or ten, and in a year or two, many more.
Currently, investors have access to funds like ETFMG Alternative Harvest ETF (MJ), AdvisorShares Pure Cannabis ETF (YOLO), and AdvisorShares Vice ETF (ACT). The last two are quite new, with only a few tens of millions of dollars under management, so I wouldn’t recommend them yet. That leaves ETFMG Alternative Harvest, which manages about $1.2 billion. That’s not a huge amount, but it’s workable, and there’s no real alternative yet.
This is a global fund: about 49% of its portfolio is Canadian companies, 32% U.S. companies, plus British (about 13%), Swedish (2.1%), Italian (1.9%), Japanese (1.76%), and others. On one hand, this is great, but on the other, since markets develop differently in each country, it averages out the fund’s results.
The focus is on medical cannabis companies: pharmaceutical and biotech firms using cannabis in their products. Of course, investors are interested in returns. Here, I have to disappoint you: you won’t see the kind of returns from the earlier cases in a global fund with such a diverse portfolio.
The fund’s two-year chart looks like a real roller coaster, with sharp rises and falls. Over two years, a long-term investor would have earned just 7.82%. Perhaps over a longer period, the fund will show more impressive results—this is a case where there’s less risk, but also less reward.