An Industry That Could Be A "Savior"

A few years ago, the investing world was enthralled with the idea that the marijuana industry was going to be the ‘next big investing trend.’ Unfortunately, for most who bought into the hype, the investments in the industry have not lived up to their promises. However, that may soon be changing.

The big marijuana players and their investors have all suffered over the years for several reasons. First, the industry is simply too fragmented for a single or handful of players to dominate the landscape. This is an issue because while competition is good, too much competition doesn’t allow individual companies in the industry to experience the power of ‘scale.’

What that means is, let’s say a marijuana company opens a farm. The farm may be large enough to produce 100 pounds, which is enough to cover the costs of the farm and the farmer. However, that 100 pounds aren’t enough to cover the cost of the transportation of the product from the farm, the distribution center, the security for the farm and distribution center, or the research and development so that the farmer can become more efficient and offer different strains. The fragmentation of the industry also hurts pricing power. The more competition means people trying to push product, perhaps simply to cover costs, means prices hit near rock bottom.

Another reason the industry has suffered is the very slow progress of legalizing marijuana both in most US States and the vast majority of countries around the world. With only a handful of states in the US having legalized the plant and the Federal Government still considering it a controlled substance, adoption rates around the country have been sluggish. When the industry was expecting to grow due to increasing numbers of legalized States rapidly, investors were pouring money into them. However, that money has begun drying up, which is now causing problems on balance sheets and debt levels.

Finally, with the halt on new States legalizing marijuana, future growth prospects have almost stopped. No or slow growth is not what investors want to see, especially if balance sheets and financials aren’t rock solid. And with no new growth on the horizon, unless new States or countries change their laws, the marijuana stocks have flatlined.

But this all could be changing in the near future.

The mandatory economic shutdowns that occurred in March, April, and May, have put State and local government budgets in dire situations. When California and Colorado passed laws to legalize marijuana, the big push came as the sale of the product would increase tax revenues. In some cases, there have been arguments made that the increased tax revenue was lower than expected, but the fact of the matter is and was, tax revenues did increase for governments due to the legalization.

When lawmakers sit down and start considering their options on how to close budget gaps in the future, it’s hard to see how marijuana will not at the very least be mentioned as an option in most states, if not all.

So, if we do see a wave of new states passing laws to allow marijuana usage and sales and because of the highly fragmented nature of the industry, the best way to profit from these potential changes is through owning marijuana-based Exchange Traded Funds.

There are currently nine marijuana ETFs, but five of them have net assets under management under $10 million, meaning they may not survive until the next wave of marijuana legalizations occur. So, starting with the largest, we have the ETFMG Alternative Harvest ETF (MJ), with over $560 million in assets. Then the AdvisorShares Pure Cannabis ETF (YOLO) with $46 million in assets. Next, the Indxx MicroSectors Cannabis ETN (MJJ) has $29 million in assets, and the Cannabis ETF (THCX) has $19 million in assets.

Sticking with the larger ETFs in this space should also help protect you from bankruptcies in the industry if we continue to see marijuana business’s hurt from mandatory business shutdowns both in the US and worldwide. With that being said, this industry is still very risky, and there are no guarantees that governments will change their tune in terms of legalizing the drug. However, if they do, getting in early will produce the largest returns.

Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: Matt Thalman owned shares of ETFMG Alternative Harvest ETF and AdvisorShares Pure Cannabis ETF at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.