Over the last couple of decades we’ve seen a slow but steady move towards legalization of cannabis. But now things are really accelerating, with the legal status of cannabis on the agenda of governments and international organizations everywhere. This is opening up big opportunities for investment, but some awareness of the landscape is needed before diving in. Here we provide a brief overview.
Over the last few years, support for the inclusion of the cannabis industry has been on an upward trend, as evidenced by the increase in markets where there is some type of legal framework for medicinal, industrial, and recreational applications. We’ve all heard of the revenues generated by companies and governments, as well as the market value projections for the next few years.
Cannabis investing outlook and considerations
Investors around the world have shown increasing interest in investing in the industry anticipating excellent returns. We believe it is important to have an educated opinion with a solid frame of reference, however, so we share our market outlook for the next 10 years.
As investors, it is worth remembering that the cannabis plant has different molecules that we call cannabinoids, it is worth mentioning that the increase in research budgets around the world has generated knowledge of new cannabinoids in addition to THC and CBD. With different applications such as CBN that shows properties to help sleep. Undoubtedly, this will continue to evolve according to the resources and attention devoted to understanding the plant.
From legalization to experience
To understand where we stand we need to know the history of the plant through the ages and the interaction it has had with civilizations. Let’s take, as a window of reference, the last 20 years where we have gradually gone from a worldwide prohibition to a process of legalization in different parts of the world. Now we are entering a period of accelerated legalization that will lead us to have a global cannabis market similar to any global industry.
This means that in terms of consumption habits, most of the market is in the process of discovery, as is the product offering which is just beginning to explore different methods, applications and preferences in different markets.
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Looking at what is happening with consumer products, we can assume that the trend is towards experiences, as is the case in the wine, food, and alcohol industry. Looking specifically at the alcohol industry as it moved from prohibition to legality, we can assume that the move from product discovery to experience happens exponentially on an accelerating curve. This will lead us in the coming years to find products or services with a vision of experience. We believe that a business model that includes this approach in its thesis is being sensitive to the evolution and interaction of the market with the plant
It is important to mention that comparing the alcohol consumption industry with the cannabis industry is not the right thing to do, as the former does not represent industrial, medicinal, or wellness-associated applications. The most comparable from our perspective is the recreational part in terms of possible market behavior in its different segments.
B) The argument for investing in the cannabis industry
Regardless of how we decide to invest in the industry, let’s remember that it can be live, in the stock market (stocks, ETF’s), in mutual funds or in companies that service the industry. There must be a good argument in favor in order to make the decision.
There are arguments as to which part of the supply chain is the right one to enter based on profitability, scalability, risk, regulatory factors, etc. The reality is that regardless of the part of the chain in which it is decided to invest, the main assumption of most strategies is the potential growth of the market.
There are published studies in which the global cannabis market is expected to grow 5 times between now and 2023, taking the example of markets such as Canada and projecting them to markets such as Germany, the United States, and Mexico.
Under this narrative, investors who know how to choose well will undoubtedly enjoy good returns in the coming years.
C) The argument for NOT investing in the cannabis industry
In our view there are two narratives that support why not to invest in the industry at this time. The first is that the growth projected by analysts will not be achieved in the times they anticipate, and the second, speaking specifically in the stock market shares, is that this growth is already discounted in the valuations of the companies via their share price. One argument that supports this narrative is that the U.S. government will not open the market federally any time soon, which is why companies will not be able to operate at the federal level and will continue to have regional presences.
There is a risk in the market dynamics that could cause that, if the projected growth occurs, but that it will not be enough for the companies to be able to operate at the federal level, they will continue to have regional presences.
There is a risk in the market dynamics that could cause the projected growth to occur, but the companies in the industry may not be able to capture the benefits, given that the growth occurs in the gray or informal market.
D) Expected volatility in the prices per ounce of raw material
As investors we must analyze the possible behavior of the price of the raw material in any of its applications: recreational, medicinal and industrial. For this analysis we believe that we must distinguish between the industrial market and the recreational and medicinal markets.
In the industrial market, the tendency is for prices to stabilize in a pure supply and demand dynamic. Where the plant fiber is seen as a raw material for different industrial processes and the added value is created at another level of the supply chain.
In the recreational and medicinal market, the perspective changes since the user has the expectation that the products in any of their presentations have a performance.
This gives rise to the possibility that creators of consumer products in these categories can generate added value through sensations and characteristics that meet a need. This could result in very wide price bands where the value of an ounce is a function of the value it generates for its market.
Currently in the U.S. market and derived from the stage we are in (accelerated legalization), we can observe market dynamics that show price volatility caused by imbalances in supply and demand, mainly in recently legalized markets where demand increases and supply is limited to legislative and regional production times, resulting in a channel unable to meet demand.
E) Value Generation in the Cannabis Industry
We believe it is important as a business strategy and as investors in any industry to understand where the value added is generated and to recognize that as an industry develops, value is generated at different stages of the chain.
What we have observed in the last few years of gradual legalization is that value added was initially generated simply by having the product available in a legal framework with or without any other specific requirements.
Today, we can analyze markets further along in the legalization process, such as the Canadian and California markets, where we can already observe established consumption patterns.
We observe consumption behaviors that are replicated from other industries such as the category of craft cannabis similar to the craft beer market. We also have the case of topical products that fill the need for wellness and become direct substitutes for well-established products in the skin care industry, among other behaviors.
To learn more: Summary of the history of cannabis
Regardless of the value generation strategy, we believe that data analytics leveraging technology is a factor that will be very important for industry players to make accurate and informed decisions in a market with relevant regulations where policy compliance is critical for business continuity.
To invest or not?
In the coming years there will undoubtedly be companies that manage to capture a market and become excellent profit generators, however, there will also be companies that fail to take off and result in losses.
Investors in the industry should be aware of the risks associated with the business, as well as be calm in times of volatility derived from accelerated growth and structural changes that may occur in the next 10 years.
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First published in ENTREPRENEUR , a third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.
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