A Looming Challenge for Pot Stocks

Although Aphria Inc (TSX:APH) is off to a bad start to 2018, it still has a lot more upside than smaller cannabis stocks do.

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Marijuana stocks saw incredible growth in 2017, but this year the results have been a bit more subdued. Year-to-date returns for Canopy Growth Corp. (TSX:WEED) have been a very mortal 13%, while Aphria Inc. (TSX:APH) has dropped by more than 20% in value to start the new year.

While these stocks still have a great deal of growth potential ahead of marijuana legalization, new entrants will face an uphill battle. The challenge for cannabis companies is that the industry is becoming very fragmented.  Competing for market share will thereby prove difficult, especially given that limits on advertising will render it a challenge to create brand recognition and loyalty. One way for a company to establish its brand is through its products and its packaging.

Sample packaging

Earlier this week, Health Canada unveiled its vision for pot packaging, which will be plain and contain a warning. The packaging will also display a company logo, with some restrictions, of course.

The packaging will also display a red stop sign that includes a marijuana leaf to easily communicate that marijuana is contained within.

Health Canada gathered feedback from various stakeholders regarding the visual elements of the packaging, and believes that it is aligned with what the public wants to see. With marijuana legalization expected as early as this summer, Health Canada was also under pressure to complete the unveiling quickly in order to ensure that suppliers would be ready.

The balance lies in determining what’s fair to companies and the public, particularly when it comes to ensuring that the packaging doesn’t make the products appealing to children.

Why this matters to investors

While this may seem like a trivial issue, the tobacco industry faces heavy restrictions and tobacco companies are doing very well for themselves. The  cannabis industry is very fragmented, however, with limited ability to advertise on the packaging or elsewhere. Thus, it will be very difficult for smaller companies to pose much of a threat to Canopy Growth and the big players in the industry.

Bottom line

If you’re looking to invest in the cannabis industry, then you’re better off buying shares of established companies. When marijuana is legalized and consumers purchase pot, there will be little reason to choose an unknown product, as consumers will be tempted by such brands as Canopy Growth or Aphria.

This is not to say that smaller companies won’t see growth, only that it will be more of an uphill battle for cannabis stocks that haven’t already established much of a presence in the industry.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor David Jagielski has no position in any of the stocks mentioned.

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