“Now For The Buzzkill”: Why Weed Stocks Might Be Too High For Their Own Good

“Now For The Buzzkill”: Why Weed Stocks Might Be Too High For Their Own Good
Milou Beunk

about 3 years ago3 mins

Mentioned in story

What’s going on here?

Share prices of North American cannabis companies have been getting giddy in recent weeks as investors salivate at the prospect of federal legalization in the US under the next presidency. In my view, however, such prospects could easily vaporize and then weed stocks could once again struggle.

What does this mean?

In 2018, Canada became only the second country in the world (after Uruguay) to legalize cannabis for both recreational and medical use. The Canadian recreational market, however, has failed to grow large enough to allow any of the numerous listed North American weed companies to thrive.

Investors are therefore understandably excited about the potential opening up of the much larger US target market. Both the biggest cannabis exchange-traded fund (ETF) in terms of money invested – the ETFMG Alternative Harvest ETF – and the biggest single cannabis stock – Toronto-listed Canopy Growth – have risen more than 40% since the US presidential election, compared to a roughly 10% gain for the US S&P 500 stock index. But the White House turning blue doesn’t necessarily mean that nationwide purple haze is a given.

Cannabis stocks performance
Performance of biggest cannabis ETF and biggest single cannabis stock. Source: Koyfin

It’s true that two recent pieces of positive news have helped send cannabis stocks surging. First, five more US states voted in favor of some form of legal relaxation last month: medical use of cannabis is now legal in a grand total of 47 states plus Washington DC (of which 13 states only approve the non-psychoactive component of cannabis), while 15 permit recreational rolling up. Second, the US House of Representatives this month approved landmark legislation that would remove criminal penalties across the country for the manufacture, distribution, and possession of weed.

Geographic overview of cannabis legality
Just don’t toke in Idaho… (Source: Wikipedia)

But now for the buzzkill. For one thing, decriminalization falls well short of full legalization: cannabis would remain illegal, with significant barriers still remaining to its large-scale production and dissemination. For another, the House vote is principally symbolic, and will almost certainly be blocked by the Republican-controlled Senate – which means it probably won’t become law anytime soon. In the US, both chambers of Congress have to approve legislation before the president can sign off on it. Sure, there’s a chance that the Senate ends up under effective Democratic control following election run-offs next month, but that race is too close to call.

Why should I care?

US legalization would make the above-board cannabis business far more lucrative – and not just for the obvious reason that firms would suddenly be able to sell to tens of millions of Americans. Access to better financial infrastructure (including cheaper loans) and a less onerous tax regime would likely allow currently struggling cannabis companies to become profitable.

At present, US weed firms are subject to an old US tax rule that prevents them from deducting business expenses if they’re engaging in federally outlawed business activity. They also face hefty interest rates on loans and are unable to accept credit cards or open bank accounts due to a ban on banks supporting illegal activity. A 2019 House bill which attempted to change this was – you guessed it – blocked by the Senate, and has since been snowed under by more urgent matters.

So while signs of increased political endorsement are certainly positive, it’s worth remembering that it’s been 24 years since the first US state legalized cannabis – and I reckon it might be a few more years yet before legal weed rolls out across the country. Not only is the president-elect no fan of full legalization, but the Senate may well remain in unsympathetic Republican hands for some time to come.

Of course, I could be wrong – and I wouldn’t be the first to underestimate political swings. Opinion polls, after all, haven’t exactly had a great few years. But to base an investment decision on foggy political outcomes – especially when they’re this momentous – doesn’t seem sensible. For me, legal US cannabis seems like a bridge too far in the near term. And until that happens, companies in the nascent industry will probably continue to struggle. My take? Don’t get too high on weed stocks just yet.

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