Should You Invest In Marijuana Stocks?

By: Andy Obermueller of Street Authority

Let me start off by saying that today's essay is not for everyone. But as Chief Investment Strategist for Game-Changing Stocks, it's my job to bring readers the best aggressive growth investing opportunities the market has to offer.

If it just so happens to come from an industry that some find morally objectionable, then so be it.

But I received a question from a subscriber the other day that I know many of our readers have been wondering about: Should I invest in marijuana stocks? If so, which ones should I be looking at?

Most Americans, about 62%, live in states where cannabis of some sort is legal for medical or recreational use. And more states are either legalizing marijuana or taking fairly significant action to decriminalize.

This is a good move. In fact, had Ohio approved its recent legalization initiative, the pro-cannabis United States would have, for the first time, had enough votes in the Electoral College to decide the presidency.

Cannabis is not a drug. Cannabis is food. I know that's a controversial statement, but I believe it. There is a scientific basis for this: Our bodies contain two types of receptors, CB1 and CB2, whose sole function is to uptake special chemical compounds known as cannabinoids. If you do not ingest cannabinoids, then your body simply makes them.

Cannabis has been shown to have remarkable healing properties for a huge swath of medical conditions. It is known to be cytotoxic to breast cancer. It is an excellent supplement to chemotherapy to decrease nausea. It stimulates appetite in HIV/AIDS patients.

I have seen clear evidence that cannabis can literally make Karposi sarcomas fall off. It's painful, but it works. Marijuana is an excellent treatment for those who struggle with mental illness and for whom sleep is elusive. It's the best choice for treating epileptic seizures, and for those who otherwise would have to take anti-seizure medication, such as my wife, who had a brain tumor removed.

It is impossible to overdose, and it's relatively cheap. The side effect is laughter. Marijuana can be administered in a number of ways, from the traditional rolled joint, which I personally think is a poor health choice, to transdermal skin patches, edibles, vapor cartridges and highly concentrated forms like wax or shatter. For patients who desire to use cannabis but who prefer not to "get high," a substance called citicoline can be added that mitigates the psychotropic effect while still delivering the profound medical benefits.

The Economics Of Pot
A master grower, either in an indoor grow facility with artificial lights, a greenhouse or simply outdoors in soil, can typically produce a pound of cannabis for less than $1,000. Economies of scale can halve that. It takes special lights -- about 1000 watts per 25 square feet of grow space, or canopy, which requires a lot of power. Cannabis also likes nutrients and water at a certain pH.

A pound of cannabis flower, or bud, goes for about $3,000 in today's market. An ounce, the most common unit of measure, ranges in price in legal dispensaries, but $250 is a good average.

This already looks like pretty good business, right? I mean, if it takes $750 to grow a pound and you can sell it retail for three grand, that's a decent spread.

But, oh boy does it get better from there. You see, the money shot with cannabis is the same as it is with any commodity -- the profit is always in the value add. (You want to be a farmer or do you want to be Archer Daniels Midland [NYSE:ADM]?)

With cannabis, the value add is extraction. This is the future of the business. A pound of cannabis, worth $3,000 as bud, is actually worth a lot more if you do the work of taking all the cannabinoids out. This extraction process, typically accomplished using a solvent like CO2 or butane, leaves pure cannabis oil. This oil can be used in edibles or vapor cartridges or other applications.

A joint has about 10 mg of THC, the principal psychoactive chemical found in cannabis. A 500 mg vapor cartridge costs about $70 retail. I know from my research that a pound of flower contains roughly 68,500 mg of oil.

Let's do that math. Buy a pound for $3,000. Extract the cannabinoids. Then sell them at retail. 68,500 divided by 500 is 137, which means that at $70 each, the cannabinoids from just a pound of flower would yield 137 cartridges worth $9,590. One plant in a greenhouse can produce about a pound on average.

The potential for scale is readily apparent.

This is big business. Already in Colorado, excise taxes on cannabis exceed that of alcohol, and some have suggested that weed will wind up being bigger. I think that's true.

But...

Cannabis sativa is a Schedule 1 drug under the 1971 Controlled Substances Act, a class higher than cocaine. This classification was bestowed by Richard Nixon in stark opposition to what his own blue-ribbon panel recommended. It means that the drug has a high potential for abuse and no known medical uses, which is curious.

Why? Take a guess who actually holds the patent on medical marijuana. If you guessed Uncle Sam, you're right. The old guy has been talking out of both sides of his mouth about weed ever since it was outlawed in the early 1930s.

Why did that happen? Because the DuPont family didn't want nylon to have to compete with cheap hemp fibers, and William Randolph Hearst didn't want his timber interests in the Pacific Northwest to play second fiddle to hemp, either. So they joined forces and bought a law, one that Nixon and Nancy Reagan ran with. The fact is, almost everything that the Just Say No campaign taught about cannabis is false. But cannabis is still there as a Schedule 1 "drug."

Now, the Obama administration has been hands off, letting the states decide the issue for themselves. And Congress, to its credit, has defunded the Drug Enforcement Agency's efforts to interdict medical marijuana in states where it is legal. That's all well and good.

Should You Invest?
But there is still a problem for potential investors in this space, and that problem is the Financial Industry Regulatory Authority (FINRA). Wall Street's main regulator just isn't going to countenance an S-1 filing from a cannabis company looking to go public while the drug is still classified as a Class 1 controlled substance. There has not been such a filing to date. Every cannabis company that trades has been the product of a reverse merger, not an IPO.

Almost every one of these companies, in my view, is a complete scam.

Eventually, cannabis will be reclassified and FINRA will allow IPOs. Big Pharma and others will step in to meet the demand, which I estimate exceeds $100 billion a year in the United States alone. But until that time, I cannot advise anyone to take a position in the market as currently constituted. Many of the companies trading are, in my opinion, less than honest.

We're just not there yet.

When we are, and I suspect this is five or seven years from now, the companies that have the greatest likelihood for success will be those that have significant vertical integration that spans the value chain from clone (very few plants are grown from seeds) to the dispensary shelf. Extraction is one key, and consistent quality is the other.

I have a lot of friends and a strong personal interest in this business. I keep up with the developments. And when the time comes to invest, I will let you know. We're just not there yet.

In the past year, Street Authority recommendations on individual stocks have gained +72%, +26% and +60% all in less than six months... and recently, their trades could have made you +26% in 42 days and +42% in less than one month. Click here to get the free trading advisory -- Trade of the Week.