The marijuana fans in California had something to celebrate in start of 2017 as the state allowed the legal sale of marijuana for the first time.
And it’s not just California. Colorado, Alaska and Maine are among the other states in the US that allow drug use. Many other states allow marijuana to be sold and consumed for medical purposes. It is expected that Canada will be the first G7 country to fully legalize the drug, probably by the middle of this year.
For us, therefore, the question arises as to whether we as investors should observe this trend. Finally, there are listed companies in this field.
Back to the basics
There are great benefits of investing early in a looming and potentially very big trend.
Global cigarette sales in 2016 were in the $700 billion range. Not that we should expect marijuana sales – even if the drug was suddenly legal anywhere in the world – to even approach that level. But it offers a perspective as the data on illicit drug sales are a little harder to come by.
In a 2005 United Nations report, the global market for marijuana was estimated at over $ 140 billion. And that, even though it was illegal almost everywhere.
So we can see that the eventual potential market for the drug could be massive.
But that does not mean that you should immediately buy shares in companies that sell marijuana or have “marijuana” in their name. We still have to do our homework to make sure the company we invest in is a quality supplier.
Why? When it comes to such trends, even if the trend prevails, not every company that wants to profit from it is a good investment. Let’s take a look at some of the reasons why.
First on the market is good …. but great is better
There are clear benefits of being first in the market, especially in an emerging industry. If a company has a big head start, it can be very difficult for competitors to catch up. Amazon.com was one of the very first companies in the world of e-commerce, and it was tough for new e-commerce operators and other businesses to catch up.
However, there are many examples of emerging industries that have shattered the early innovators and frontrunners of companies that were “late” but simply better.
In the Internet search companies like AltaVista, Ask Jeeves and Yahoo! all before Google in the market, but Google was in the end the winner in this market. BlackBerry and Nokia were market leaders in the mobile phone market before Apple launched its first iPhone, but Apple dominates the market, while the other two have almost disappeared. Friendster, MySpace and hi5 were also in front of Facebook, but we know how the story ended.
The point is, do not assume that a company, just because it’s early, will be a winner in the long run. Even a company that is “late” can beat companies that used to be in the past.
The economy of today is unlikely to be the economy of tomorrow
In an emerging industry like this, there will likely be economic shifts as the industry evolves and new competitors join. Although further legalization of marijuana – for example, if Canada legalizes it for recreational use – could be a huge growth driver for established companies, it could also encourage a lot of new companies to participate.
When new companies enter the market, some may focus on specific market segments – for example, by selling to the high end of the market with a very high quality product. But others can try to gain market share with lower prices.
The companies that hold a strong position today may find it difficult to compete if their offer is not more favorable than the low-cost entrants or sufficiently different from the other newcomers.
Selling grass is not enough
In short, for a marijuana company to be worth an investment, it must be more than just a company selling marijuana. It has to have the same things we are looking for in every business: Trustworthy management; clear and lasting competitive advantages; intelligent capital allocation; sustainable financing; and so on.
Although this market could offer huge growth, we also need to take the ratings into account. As the largest Canadian marijuana companies have a price-sales ratio of 50 to nearly 200, it seems they are not currently cheap.