Tips for Investing in Cannabis

So many people get tripped up or freaked out about the idea of investing in the cannabis industry, as if it is somehow a foreign concept, when in actuality many of the investment opportunities in the cannabis space have an interesting and financially sound platforms to their business models. The opportunities in cannabis sector are prevalent, and remind me of the emerging technology market of late ’90s. Accordingly, I believe that the cannabis industry is on the brink of an enormous growth cycle. Here is why:

Back in 1996, as a young broker working in the financial markets, I was fortunate to get involved in many aspects of the technology market. This sector was exploding with growth and opportunity, with many new companies developing and marketing all sorts of technological advancements.

One of the companies I came a came across was a chip maker by the name of C-Cube Microsystems. The company had excellent financials and was quite easy for me to discuss with investors as their revenues were on the rise, several of their financial ratios were at very attractive levels and their margins and net income were strong. As a broker, I had learned to look for specific key variables, all based in fundamental analysis, and I hardly dwelled on the industry in investment decision making process for my clients. I was primarily basing my decision on quantitative modeling to vet my investments, remaining open to investing in any opportunity that met the criteria.

Often times in proposing the new investment I would dive right into the numbers: C-Cube Microsystems was profitable with increasing revenues both year-over-year and quarter-over-quarter. They had attractive margins, their long term debt to equity ratio was low, and their cash and assets over bills was high. Inevitably, the question would arise, “Alex, what do they do?”

“They make chips,” I would reply, explaining Peg Ratios and other important financial metrics. The client would ask, “What kind of chips?”

“Their chips are used in set top boxes for DVD players,” I replied.

That was my favorite line. I usually just let it hang out in the conversation like a lead balloon. I would stay quiet at this point, knowing the next question my client would ask.

“Oh,” the client would say. “What’s a DVD player?

At that point, I would proceed to explain how super cool a DVD player was, and what they were capable of doing. After all, a DVD disk could hold much more information than a CD (which everyone was familiar with), and the fact that the video quality using a DVD player was such a significant improvement than VHS tapes, it was trending to be the next standard.

The only concern my clients voiced was whether or not we were buying another VHS versus Betamax boondoggle, potentially risking backing the wrong standard. I assured the clients this was not that type of scenario, and more over, it was in fact quite the opposite.

Instead of trying to speculate on which company would make the best DVD Player, Toshiba, Panasonic, Sharp and other manufacturers would simply buy the technology that enabled the device. Specifically – the encoding and decoding chips that C-Cube manufactured, which enabled the process to work regardless of the brand. It was a “Picks and Shovels” approach to the technology, and it worked like a charm. Now the VCR is a thing of the past. How many people reading this now can say they even own a VCR anymore? DVR players and Netflix hadn’t even been conceived of yet!

How does this all relate to investing in cannabis?

In several ways actually. Number one is related to the fact that only four states: Alaska, Colorado, Oregon and Washington, plus Washington DC have recreational legal models. However, combined, they sold roughly $5 billion worth of cannabis in 2015.

That’s a lot of green! Truth be told, people are buying a lot of cannabis in this country. In fact, it is estimated that nationwide the illegal market is tallying revenues of over $50 billion annually  and I speculate it is more like $80 Billion, meanwhile the legal market is growing. Eight states are set to vote on recreational or medical cannabis this November.

I would like to point out a few things at this point. First off, I had no idea how many people would buy a DVD player nationwide, but we do know roughly the size of the massive revenues generated by the illegal market which our country fails to benefit from in any way. Currently the United States showcases a 58 percent approval rating for recreational cannabis and 75 percent acceptance for medical use. With cannabis laws loosening nationwide, and a high likelihood that come November, 25 percent of all states will have adopted recreational laws, it is clear to me we have reached a tipping point.

As far as I am concerned, the five most dangerous words on Wall Street are, “This time it is different.” It never is and cannabis will follow the exact same product growth and adoption cycle as every other emerging market product, ever.

We are well beyond the mom-and-pop phase and breaching the introductory phase, as cannabis education and awareness take hold in this country. Next will come the growth phase and “growth is good.”

Cannabis has so many products it’s exciting. Medically it’s a godsend and recreationally it’s a less toxic alternative to alcohol, but economically, perhaps even more exciting, is the potential of industrial hemp market. Hemp a non-euphoric form of cannabis that can be converted into medicine, food product, fabric, fuel, paper, polymers, cleaning supplies and building materials. Each of these hemp based options offers an eco-friendly alternative to its predecessor and is far more sustainable for the planet.

Furthermore, it would be easy to employ a “picks and shovels” approach to cannabis as many ancillary businesses such as laboratory testing, seed to sale software will be essential to pave the way to a safe and responsible industry. This will serve to increase acceptance of cannabis nationwide, which will further fuel the investment opportunities for years to come.

Do you have ideas for investing in marijuana?