Investor’s column: The pros and cons when considering an investment in marijuana stocks

No pun intended, but there’s a big buzz about the marijuana industry these days.

Marijuana was illegal in 1995. In 2018, more than half of U.S. states have legalized medical cannabis — and nine allow recreational use.

Mexico legalized medical marijuana in 2017 and this year, Canada became the first industrialized nation to legalize recreational pot.

So with such sweeping changes, is it time to invest in marijuana stocks?

Potential investors need to be cautious. While the marijuana industry in the U.S. is relatively young, there’s a lot of money being made, so viability is likely good.

BDS Analytics estimates this emerging industry generated $9 billion in sales in 2017 and forecasts $57 billion in worldwide sales by 2027. How much of that turns into profits is debatable, however, as the industry still faces significant challenges.

Marijuana remains classified as a Schedule I substance under the Controlled Substances Act (CSA). Therefore, manufacturing or dispensing marijuana remains federally prohibited. Any revenue these businesses deposit into a federally insured bank technically violates federal law.

Furthermore, handling marijuana transaction proceeds is considered money laundering. Therefore, few banks are willing to accept that risk.

As a result, the industry has largely operated in cash because it can’t accept credit cards or checks that process through banks. The risks from operating a mainly cash business are high.

If that’s not enough, even though marijuana businesses are technically illegal federally, the government doesn’t mind taxing it.

Section 280E of the tax code states that businesses trafficking in federally prohibited “controlled substances” can’t use many of the tax deductions and credits taken by other businesses. So a marijuana business that isn’t using creative accounting can pay effective tax rates as high as 70 percent (compared to the current 21 percent tax rate for corporations).

Potential investors in the marijuana industry must realize that U.S.-based pot businesses are listed on the New York Stock Exchange or Nasdaq. Most trade in the OTC Markets, which have less-stringent filing and disclosure requirements, so it could be difficult to obtain sufficient information to make a wise investment choice.

And since the marijuana business has been a hot topic lately, it also has caught the attention of scammers. It’s ripe for fraudsters who lure potential investors with optimistic and potentially false or misleading statements (designed to create high demand for a new company). Once share prices peak, scammers will sell off their shares at a profit, leaving unsuspecting investors stuck with potentially worthless stock.

While I am not advocating against investment in the marijuana industry, I do feel potential investors should go into such a transaction with their eyes wide open.

Before investing, consider:

• If you received a solicitation to invest, is the source credible? Legitimate investment salespersons must be properly licensed with FINRA, the SEC or the state. Are they making claims that sound too good to be true?
  
  
• Research the operations, financials and individuals running the company as much as you can. Some new operators in the industry are fresh out of the black market; it’s not much of a white collar business — yet.
  
  
• Consider where the stock trades. If it’s on the OTC market, it may not trade frequently. It may be difficult to sell your stock, and prices can move wildly from one trade to the next.
  
  
• Do not invest more than you can afford to lose. Keep any single stock investment less than 5 percent of your portfolio — preferably much less.
  
  

Before investing, talk to your financial planner and make sure you’re not taking undue risks to your retirement plan or other goals.

Karin Grablin, CPA, is with SRQ Wealth Management, 1819 Main St., Suite 905 in Sarasota, and can be reached at 941-556-9004 or karin@srqwealth.com.