An Opportunity for Excess Profits in the Marijuana Industry

Investors following the development of the marijuana industry are keenly aware of the fantastic news that hit the headlines just last week. The Liberal government is taking the steps to make the use of recreational marijuana completely legal. While many are applauding this decision, it came a little later than others would have preferred. The net result is that the product will now be consumed in much greater quantity.

While this decision represents positive news for investors, shares of Canopy Growth Corp. (TSX:WEED) and Organigram Holdings Inc. (TSXV:OGI) both declined during the week and on the day the announcement was made. Shares of Canopy opened the week at $10.30 and closed the week on Thursday at $9.93. Friday was a holiday. Shares of Organigram had an even tougher week, opening at $3.21 per share and ending the week at $2.82. Clearly, the expectations of legalization were already factored in to the share prices.

While the industry is a very exciting growth story, the market is now in a position to expand at a very high rate as Canadians have received confirmation that the potential legalization will become a reality. For producers, this means the pie is big enough to substantiate an increase in competition should more players wish to enter the market.

The challenge producers will face in the future is that they may have no way to differentiate one plant from another. The danger for investors is paying a valuation that is simply too high for a mainstream marijuana company. Currently, Canopy has the biggest market capitalization, which is in excess of $1.5 billion. While the biggest producer may enjoy economies of scale, this is something that can dissipate over time.

Trying to differentiate itself from the pack, Organigram offers everyday marijuana, just as its competitors do, in addition to organically grown marijuana. Investors are keenly aware that the organic market has grown at a substantially higher rate in comparison to the broader food and drink market. What makes Organigram even more attractive for investors is that the additional cost to produce the product is more than covered by the higher revenues generated by the organic variety.

The bad news that came alongside the effort to legalize marijuana regards the restrictions on endorsements. Organigram made a fantastic deal with The Trailer Park Boys to brand their product, but this may no longer be permitted under the new rules.

As investors, we search for securities we can purchase today to see growth in our investments in the future. If dividends are not being paid, then the industry or the company must be growing profitably. We would expect the growth to translate to a higher share price in the future.

In this case, investors may need to be careful when selecting an investment. Without some sort of product or brand differentiation, there is no chance for excess profits. Marijuana may become no different than any other commodity.

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Fool contributor Ryan Goldsman has no position in any stocks mentioned.

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