The Most Overlooked Reason for Investors to Consider Pot Stocks?

pot stocksCan Pot Stocks Be Recession-Proof?

For the most part, pot stocks are considered to be near the higher end of the risk spectrum. And there’s a good reason for it: frankly, they’re some of the most volatile tickers in the entire stock market.

And that reputation for being risky may have overshadowed an important quality of the cannabis industry—resilience.

You see, last year gave investors a good reason to consider recession-proof stocks. The COVID-19 pandemic—along with the related shutdown measures—plunged the global economy into a severe contraction. In the U.S., second-quarter gross domestic product (GDP) plunged by 32.9%, marking the biggest drop in history. (Source: “Gross Domestic Product, 2nd Quarter 2020 (Advance Estimate) and Annual Update,” Bureau of Economic Analysis, July 30, 2020.)

Unsurprisingly, investors rushed toward industries that have a reputation for being recession-proof, such as health care, consumer staples, and utilities.

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The easiest way to see if a business is recession-proof is to check whether customers will still purchase its product or service in the event of a severe economic contraction. The three industries I just mentioned easily pass the test.

But what about cannabis?

Well, while the legal cannabis market is quite new in North America, people have been consuming pot for much longer than that. It’s obviously difficult to obtain data from the illicit market, but evidence from other vice industries (like tobacco and alcohol) implies that people would continue purchasing cannabis products during a recession.

And if you need evidence directly from the legal pot industry, take a look at the chart below. It shows the monthly retail cannabis sales in Canada in 2020.

I used Canadian data because the country legalized recreational pot nationwide in October 2018. In the U.S., different states have been moving toward legalization at different paces, so the numbers might be skewed if, say, one state had opened up the legal market right before the recession.

(Data source: Retail Trade Sales by Province and Territory,” Statistics Canada, last accessed March 29, 2021.)

In Canada, COVID-19 lockdowns started in March 2020. But as we can see from the above chart, retail cannabis sales in the country actually rose to CA$181.2 million that month. And while the number dipped a bit in April, it bounced back to $186.4 million in May and surged to $201.1 million in June.

That is, in the second quarter of 2020—when, just like the U.S., the Canadian economy took an unprecedented hit—the Canadian cannabis market actually grew.

Some might argue that pot sales were strong in the second quarter last year because people were stocking up on essential supplies. However, as the chart shows, Canadian cannabis sales continued to trend upward even after the economy started to reopen in the third and fourth quarters. Monthly pot retail sales reached nearly CA$300 million by December 2020.

In Canada, retail pot sales totaled CA$2.6 billion in 2020, which represented a 120% increase over 2019.

Mind you, these numbers only include legal sales of cannabis. If you included pot purchased on the illicit market, the numbers would be even bigger.

I should point out that, while the cannabis industry has demonstrated its resilience, it doesn’t mean every pot stock is recession-proof. Although the demand for cannabis tends to be relatively inelastic to how the economy is doing, not every pot company has come out of the pandemic in the same shape.

Due to the cause of the recession, there have been many operational challenges facing the cannabis industry. Companies that were able to address these challenges and adapt to the new environment—such as by ramping up their pick-up and delivery services—turned out to be more successful than others.

Analyst Take

In almost every legal cannabis market, the growth story is just unfolding. In Canada, where nationwide legalization happened more than two years ago, people are still moving their purchasing from the illicit market to legal dispensaries.

The argument for growth would be even more valid in the U.S, where federal legalization is yet to take place. That is, the market is expanding and the growth momentum could carry cannabis companies through the ups and downs of the economy.

When more people realize the recession-proof nature of the cannabis industry, it could give pot stocks some new investor appeal.