Once the Marijuana Industry Tackles This Problem, Pot Stocks Will Soar

After the Pot Industry Tackles This Problem, Marijuana Stocks Will Soar
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Marijuana Black Market Harms Pot Stocks

One of the most consistent issues facing the legal marijuana industry is that so many of the potential profits are being siphoned off by the black market.

Despite legalization coming into effect in Canada and many parts of the U.S., that hasn’t prevented the pot black market from continuing to thrive. Governments need to tackle this problem. And once they do, marijuana stocks will likely soar.

Pot stocks, you see, are entering a very important time in their maturation process. With legal markets now widely available (Canada, 11 U.S. states, and D.C.), companies are no longer able to skate by on future projections alone. Instead, they need to provide concrete numbers that demonstrate growth in addition to promising more gains in the future.

The big problem though is that netting those profits has been harder than anticipated. Or at least, that’s how it looks for casual industry followers. For those of us who have been closely tracking the marijuana industry, its early stumbles aren’t all that surprising.

A primary concern for the marijuana industry is the extremely robust black market it has to contend with. Black-market participants don’t pay taxes, licensing fees, minimum wage, employee benefits, etc. so their overhead is a lot smaller. That allows them to sell pot at a much cheaper price.

Usually, the drawback here is that everyday people tend to want to keep things legal and avoid any run-ins with the law, not to mention that legal products tend to be safer and more reliable.

But that doesn’t quite hold for marijuana; penalties for personal users are exceedingly slim. As a result, there isn’t much of a legal deterrent to indulging in black-market pot.

Furthermore, the pot black market was the sole avenue for pot users for decades. As a result, it has gained the trust of consumers. So if you can get an equal product for cheaper, with almost nothing to fear from law enforcement… Well, you get the picture. The marijuana black market simply has way too many competitive advantages.

An audit by the United Cannabis Business Association found that there are about 2,835 unlicensed weed dispensaries and delivery services in California, the largest marijuana market on Earth. (Source: “Nearly 3,000 illegal marijuana businesses found in California audit, dwarfing legal trade,” Los Angeles Times, September 11, 2019.)

Compare that to the relatively puny legal market in the state, made up of only 873 licensed cannabis sellers.

The results have been devastating for marijuana stocks: another industry-backed audit found that about $8.7 billion will be spent on unregulated cannabis in California this year. In the same period, it’s expected that there will be about $3.1 billion spent on cannabis sold by legal operators in the state.

Marijuana companies that rely on showing strong profits on their quarterly reports are seeing so much of that potential profit being vacuumed away by the pot black market.

So what’s the answer to this problem? The solution is quite simple: governments need to get out of the way.

The key reason that people are continuing to indulge in the marijuana black market is that they view it as selling an equivalent product for a cheaper price. The best way to combat that is to, then, reduce the cost of legal pot.

Governments are the key reason that legal weed is priced as high as it is. Many U.S. states and Canadian provinces were able to pass marijuana legislation in large part due to the promised millions of dollars in tax revenue that the governments would reap as a benefit.

The idea was to legalize pot, tax profits, and pay for things like roads and schools. It’s a powerful argument and one that helped see a surge in marijuana legalization across North America.

The problem is that the taxation and licensing fees are actually preventing these governments from earning their potential revenues.

Consider some back-of-the-napkin math here. If marijuana is being taxed at 20% and the entire sector earns $1.0 billion, that means the government will stand to make $200.0 million. Imagine that taxes were reduced to, let’s say 15%, resulting in $1.5 billion in profit. The resulting tax revenue would equal $225.0 million. In this case, less taxation would mean more government revenue.

Now, this is a common argument for trickle-down economics. While I don’t support that line of thinking in most cases, when it comes to marijuana, there is such an obviously massive pot black market that some of the obstacles need to be removed from the legal market in order for it to be able to compete.

And the best part is that, once the legal pot sector is able to effectively snuff out the marijuana black market, governments could raise taxes to their desired rate. It could benefit tax revenue in both the short and long terms if executed correctly.

To be fair to governments, there is some progress being made to combat the black market. Canada, for instance, is going to legalize edibles in December.

In Canada, it is rather easy to obtain edible marijuana from black-market storefronts operating outside the law. Edibles coming into the legal market, however, would help draw some of those wayward consumers back into the fold.

After all, if people get all their marijuana needs served by a legal provider, rather than only certain products, they will be more likely to stick with legal pot retailers for all of their purchases.

While it’s nice to see progress, if government regulation takes a step back, that would go a long way toward leveling the playing field.

Legalizing more cannabis products will be, of course, a boon for pot stocks, but even that will just be a drop in the bucket until marijuana pricing deficits between legal and illegal cannabis are closed.

Another solution to this problem is, of course, to wait out the black market. The marijuana black market lacks the resources to commit heavily to research and development.

As such, there’s a decent chance that legal marijuana businesses, with their millions of dollars going into innovation, could eventually naturally displace the black market by reducing pot prices via technological advancement. It’s a longer and less certain process, to be fair, but one that is likely to occur over time.

Still, the best recourse for the marijuana industry right now when it comes to the pot black market is to have regulators and lawmakers step in and create a more balanced playing field—at least to start. And when the black market is defeated, then taxation and regulatory fees can begin to be ramped up once more.

Analyst Take

Perhaps the biggest problem facing the legal marijuana industry right now is just how much money is being drained away by black-market sellers.

Until this problem is properly addressed, marijuana stocks simply won’t be able to reach their full potential.

It’s going to take immense coordination between private businesses and public regulators in order to soundly defeat the marijuana black market, but it can be done.