What the Trump administration's move to reclassify marijuana means for investors

The Trump administration on Thursday moved to reclassify marijuana under federal law.

In a release, the Department of Justice said it will immediately move FDA-approved marijuana products, along with items regulated by a state medical marijuana license, to Schedule III under the Controlled Substances Act, a demotion from its current Schedule I status.

That puts medical cannabis in the company of regulated drugs with recognized medical uses, such as Tylenol with codeine and testosterone, rather than Schedule I drugs, such as heroin, which are considered to have no medical use and high potential for abuse.

The U.S. Drug Enforcement Administration will evaluate whether to extend Schedule III status to cannabis broadly — not just to medical marijuana — in a hearing scheduled for June 29.

The changes haven’t and will not legalize the drug at the federal level. But for an industry that has historically feared executive authority could deal a major blow to the drug’s legality, the moves are a step in the opposite direction, says Ben Kovler, founder and CEO of cannabis firm Green Thumb Industries.

“Since Nixon’s Controlled Substances Act 50-plus years ago, this is the first major step towards opening up the product that’ll make it much more investable,” he says.

In the near term, Kovler says, the move could remove what amounts to a huge tax burden on cannabis firms. Over the long-term, continued progress could see pot firms embraced by major banks and brokerages, he says.

For now, though, the industry still faces major obstacles that retail investors should be aware of before putting money into pot stocks, says Gerald Pascarelli, a consumer equity analyst at investment firm Needham & Company.

“It’s important to note that this industry still has its fair share of challenges,” he says. “For most people interested in this space, stock price movements over the near term are going to be largely dictated by optimism or pessimism around regulatory reform.”

Stocks of prominent cannabis firms, such as Tilray, Canopy Growth and Curaleaf, all saw double-digit gains on Wednesday as investors anticipated the announcement, the result of an executive order issued by President Donald Trump in December.

That’s because a rescheduling — especially should it go through for recreational pot — would represent a major boon to U.S. cannabis firms’ finances, says Pascarelli.

Traditionally, because of marijuana’s Schedule I status, weed firms were subject to 280E taxes, meaning they had to file taxes but could not claim normal business deductions.

“The tax penalty has been a major headwind in terms of their earnings profile and in terms of their free cash flow,” Pascarelli says. “If cannabis is rescheduled to Schedule III … the biggest benefit for these operators is that it removes that tax headwind.” Free cash flow refers to the profits left over after the capital and operational spending needed to maintain a business.

In short, he says, many of these companies will see “better cash flow and a better balance sheet.”

Industry leaders say the new rules are a step in the right direction for an industry that faces the hurdles that come with the drug being federally illegal. Marijuana’s illicit status still makes it difficult for cannabis firms — even in states where the drug is legal — to secure financing and investment from major financial institutions, Kovler says. Many U.S. marijuana firms list their stocks on Canadian exchanges and trade over-the-counter in the U.S.

Remedying these challenges will require “clarity from the federal government that what the companies are doing will not be prosecuted,” says Kovler.

Thursday’s move didn’t provide that clarity, and it’s worth noting that the industry has its detractors. Speaker of the House Mike Johnsonopposes marijuana legalizationand has called it a “gateway drug.”

Still, the news could be symbolic of positive things to come for cannabis firms, says Jaret Seiberg, a managing director and policy analyst at TD Cowen.

“This is a Republican president ordering his Attorney General to take steps that benefit the cannabis sector. It suggests there could be a path forward for more substantive legislative changes though that may require the House to go Democratic,” he wrote in a December note. “Such changes would include access to capital markets and banking services for state legal cannabis.”

It remains to be seen what will actually happen, and on what timeline. That means if you’re hoping to eventually capitalize on a marijuana boom if legalization happens, patience will be key, says Pascarelli.

“You need to have a long-term view of the category — that it will normalize and there will be winners and losers,” he says.

For now, investors have access to exchange-traded funds and mutual funds that hold a broad array of U.S.-based cannabis firms, as well as some major players based in Canada. If you’re hoping to find stocks that could win over the long-term, Pascarelli recommends firms with strong balance sheets, little debt and better access to capital than peer firms.

You’d be wise to consult with a financial professional before making any major changes to your portfolio.

In the meantime, expect continued volatility among pot stocks, as regulatory tangles get sorted out, Pascarelli says.

“This is very much a long-term investment. This isn’t an overnight change in the fundamentals,” he says. “This will take some time.”

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