What’s the market like for cannabis stocks? No one seems to doubt that the future is bright, but like any still-developing industry, it can seem like the Wild West out there. It’s hard to make generalizations, much less predictions, at least in the short run. But what other industry can boast that it’s likely to more than triple its current customer base in the coming years?

It’s estimated that in 2019 total global spending on legal cannabis will be 22.9 billion dollars, of which 17.8 billion will be spent in the U.S. This, of course, is happening within a legal market of only 10 states, whose combined population represents about a quarter of the U.S. total.

Once all other states fall in line, as they almost inevitably will, that would expand the market for legal cannabis by 238%, assuming per capita spending in the new states is comparable. (See Figure 1.) No other industry has the kind of upside potential that future legalization will offer cannabis.

So cannabis stocks should be booming, right? Well, in fact, some are. But overall, not so much. Figure 1 shows the performance of the Global Cannabis Stock Index compared to the Dow Jones Industrial Average over the past twelve months (with each indexed to their value in May of 2018 by the Stash). While the Dow has been essentially flat, the Cannabis Index has lost 18% of its value in that time.

There are potentially many good explanations for this. For example, it’s possible that much of the exuberance for cannabis stocks’ future had already been baked into the prices a year or more ago, and so some of the Cannabis Index’s seemingly lackluster performance simply represents the reality catching up to more rational (but still exuberant) expectations.

But is there, in fact, a drag on the prices of cannabis stocks simply because they’re, well, cannabis stocks? Is there a “legitimacy gap” caused by some investors’ reluctance to buy into an industry that still seems to have something of a stigma about it?

Let’s let some of the leading players in cannabis share their view on the industry’s task at hand, in the form of the “About Us” section or even the home page of their websites. Tilray tells us “We aspire to lead, legitimize, and define the future of our industry…” while Canopy Growth states that the company “advances the world’s perception of cannabis.”

Hexo is “for Canadians who want to consume adult-use cannabis without stigma.” General Cannabis says “We do all of this, and more, in an effort to raise the standard of integrity and legitimacy in our industry.” (Emphasis ours.)

If legitimacy – or better perceptions or less of a stigma – is one of your stated goals, clearly the current state of your legitimacy is not what you would like it to be.

The Legitimacy Effect

To see what happens to a cannabis stock’s price when legitimacy is suddenly bestowed upon it, look no farther than the performance of four companies that basically bought legitimacy overnight – by landing large deals with established firms.

In August of 2018 Hexo announced a joint venture with brewing industry giant Molson Coors to develop cannabis-infused non-alcoholic beverages. That same month Constellation, brewers of Corona and Modelo, boosted its stake in Canopy Growth to 38% (from 10%) by investing just over $4 billion in U.S. dollars. Then in December of that year tobacco giant Altria invested $1.8 billion for a 45% stake in the Cronos Group and Anheuser-Busch InBev inked a deal to invest up to $50 million in a joint venture with Tilray.

Exhibits 3 and 4 show the stock price trends of all four cannabis companies (again, each is indexed to its respective value in May of 2018). Prior to the respective announcements, each had been moving more or less in tandem with its Cannabis Index peers (although making this statement about Tilray requires a leap of faith, in the form of a quick-and-dirty visual elimination of a major 2018 bubble in their stock price).

Afterward, each rode their newfound legitimacy to their own wild ride, leaving their former partners-in-trend far behind. But even though each of the four has declined recently, they all remain well above both the Dow and the Cannabis Index.

The Benefits of Legitimacy

These deals each had clear benefits for the respective cannabis companies in pure business terms – access to new markets, new product lines, and more – but there’s a case to be made that part of the post-deal surge in stock price was nothing more than each of these companies basking in the halo of legitimacy provided by their established, dependable, long-time-legal partner.

Still, while all of these points are reasonable there is in fact too much speculation and too many assumptions built into this discussion for anyone to make calculations based on this and run with them. But make no mistake, we’re going to crunch the numbers and we’re going to run with them. Hey, it’s only an exercise.

The combined market capitalization of these four companies is just over $24 billion. If they had performed similarly to the overall Cannabis Index – as they, in fact, had, more or less, prior to their deals – they would be worth $11 billion less. Of course, this is not all a result of the legitimacy gap alone – far from it. But it does demonstrate what partnering with a “legitimate” firm can do for cannabis stock.

This is still another reason investors in cannabis stocks should be optimistic. The industry is already poised to achieve a total market cap of $100 billion this year. We won’t even try to estimate the legitimacy gap in that figure. But while legitimacy is seemingly coming more slowly than mere legality, it is coming. And as the gap closes the growth in market capitalization will likely exceed even the growth of legal cannabis sales.