If you're nervous there could be a crackdown on recreational marijuana companies because marijuana remains illegal in the U.S. at the federal level, then medical marijuana stocks could be a better investment option. Most countries still prohibit recreational marijuana use, but laws allowing medical marijuana use are becoming increasingly common. For example, medical marijuana markets are thriving in Canada and Germany, and in the U.S., 33 states have passed laws supporting medical marijuana.

Medical marijuana may not be as big an opportunity as recreational marijuana, but it could still be worth tens of billions of dollars annually to the top stocks. Here's how investors can profit from marijuana as medicine.

A medical marijuana primer

Marijuana's use as medicine isn't new. Its use can be traced back thousands of years in China, Egypt, and elsewhere for a variety of maladies:

• In China, cannabis is considered one of 50 "fundamental herbs" used in medicine, and its use as an anesthetic is documented as far back as the second century A.D.
• In Egypt, ancient papers mention cannabis use for pain relief as far back as 1700 B.C.
• In Greece, it was used to dress sores on horses and soldiers' wounds as early as 100 A.D.
• And cannabis is mentioned in ancient Indian texts for use in a variety of ailments, including insomnia, headaches, and gastrointestinal disorders.

Its documented history of medical use in Western countries is more recent, but a study of fossil pollen conducted by the University of Vermont suggests cannabis was cultivated in Europe as early as 4400 B.C. Cannabis may have been cultivated for industrial purposes, such as for use in making rope, but migration and trade routes could also have spread word of its medicinal properties to Europe. 

In modern times, medical marijuana's use in the West is credited mainly to England's colonization of India. It was there that doctor William Brooke O'Shaughnessy studied cannabis as a treatment for muscle spasms, stomach cramps, and general pain. O'Shaughnessy's writings in the 1840s on cannabis' medical use helped establish its use in Europe and eventually in America, where cannabis became readily available in pharmacies by the late 1800s. 

Cannabis' medicinal properties stem from the impact of its chemical cannabinoids on receptors in the endocannabinoid system, specifically the CB1 receptors in the central nervous system and CB2 receptors in the immune system. The two most common of the more than 100 cannabinoids found in marijuana are tetrahydrocannabinol (THC) and cannabidiol (CBD). THC's interaction with CB1 receptors is behind marijuana's psychoactive effects, while CBD's indirect interaction with CB1 and CB2 receptors is believed to contribute to its medicinal effects. 

Medical marijuana legalization

Marijuana's been prohibited in the U.S. since the Marijuana Tax Act of 1937, and it's been a schedule 1 controlled substance in the U.S. since the passage of the Controlled Substances Act in 1970.    

Despite federal prohibition, anecdotal evidence of marijuana's medical benefits contributed to voters in California approving the nation's first medical marijuana laws in 1996, which cleared the way for its use as a treatment for cancer pain, anorexia, AIDS, chronic pain, arthritis, glaucoma, and other ailments, with a doctor's recommendation. 

California's medical marijuana market really took off, however, following the passage of Senate Bill 420 in 2003. That bill created an ID card system for patients and allowed nonprofit collectives to operate as marijuana dispensaries. Since then, over 100,000 ID cards have been issued, and hundreds of medical marijuana dispensaries have opened their doors. As a result, industry watchers estimate that medical marijuana sales in California eclipse $1 billion annually.

Since California's pioneering decision in the late 1990s, more than half of U.S. states have followed in its footsteps. Voters in Washington, Oregon, Alaska, and Nevada legalized medical marijuana in 1998, and today, 33 states have passed comprehensive medical marijuana laws, and an additional 13 states have passed laws allowing the use of CBD products. As of this writing, only four states don't have medical marijuana laws of any kind.

The use of medical marijuana isn't limited to the United States, either. In fact, some countries, including Canada and Germany, have passed laws creating national medical marijuana marketplaces.

Canada's medical marijuana market has experienced considerable growth since rules were put in place in 2014 to license patients, growers, and dispensaries. Medical marijuana sales there now total in the hundreds of millions of dollars per year.

Germany's medical marijuana market went live in 2017, and according to data from Germany's National Association of Statutory Health Insurance Funds, insurers reimbursed 80,000 prescriptions in the first six months of 2018 alone. Germany is currently importing medical-grade cannabis from Canada and the Netherlands, but its plans include licensing companies to cultivate cannabis domestically in Germany in 2019. 

How to invest in medical marijuana stocks

Investors can gain exposure to medical marijuana by investing in individual stocks or exchange-traded funds (ETFs) that pool assets from many people to invest in many marijuana stocks.

Unlike mutual funds, which are priced once per day at the market closing price, an ETF can be bought or sold at any point during the trading day. You decide how much to invest in an ETF, but because they trade like stocks, you're likely to be charged a commission each time you make an investment. Additionally, since ETFs have significant operations behind the scenes that enable the pooling and investing of money from many people in many companies, they charge annual fees, like a mutual fund, and those fees can drag down returns. 

Investors interested in owning individual marijuana stocks operating in the U.S. have limited options. Because marijuana use is illegal in the U.S. federally, medical marijuana companies are often privately owned, rather than publicly traded, and companies that are publicly traded are traded on the lightly regulated over-the-counter market, rather than a major market exchange like the New York Stock Exchange (NYSE). 

Over-the-counter stocks don't have to meet strict listing requirements, so companies that trade on this market can expose investors to a higher risk of fraud. Additionally, stock price quotes can vary significantly for OTC stocks because there is no central exchange and liquidity is questionable, which can make it tough to buy or sell at favorable prices.  

The situation is different in Canada. Because it's legal nationally, medical cannabis companies can list on the major Canadian exchanges, including the Toronto Stock Exchange. However, foreign stocks have their own drawbacks. There are usually higher trading commissions and fees, and investors must accept risks associated with converting U.S. dollars into foreign currencies (and back again). Depending on the stock, liquidity can be an issue for foreign stocks, too.

Fortunately, five of the largest Canadian cannabis companies secured an OK to list shares on the NYSE or the NASDAQ exchange in 2018. Those companies have exposure to medical marijuana through their Canadian operations, but beyond shipments for medical research, they're currently barred from operating in the U.S. by Canadian rules.

Before a discussion of individual medical marijuana stocks worth buying, here are the different types of medical marijuana stocks.

Growers 

These companies cultivate cannabis in fields, greenhouses, or indoor facilities. Fields produce cannabis at the lowest cost, but greenhouses and indoor facilities provide growers with more control over environmental factors, such as weather, pests, and nutrients that reduce waste and boost consistency -- important factors for cultivating medical-grade cannabis.

Extraction

Once cannabis is harvested, it's often processed using solvents to extract chemical cannabinoids to make oils and concentrates for use in other products, including beverages. Most medical marijuana growers also operate extraction facilities because these processed products can command higher prices and offer better profit margins.

Drug developers

Cannabis has a long history of medical use, but prohibition has made it difficult to conduct scientifically controlled trials in humans to determine whether such use is effective and safe. That's changing, though. Increasingly, companies are investing money in research to develop strains to study in trials with the goal of securing regulatory approval that sidesteps federal prohibition.

Distribution and dispensaries

After marijuana products are packaged, they need to travel through the supply chain to retail operators for sale to consumers. Medical marijuana growers can operate vertically, controlling all aspects from cultivation through retail sale, or they can contract with distribution companies that help them market their products to medical marijuana dispensaries.

Industry vendors

From hydroponics -- the delivery of nutrients to plants via water rather than soil --  to tamper-proof packaging to inventory and retail sales software, marijuana growers rely on vendors specializing in cannabis to help them decrease production costs via automation, boost yields, and comply with regulatory standards.

Top medical marijuana growers 

Canadian marijuana companies are the largest and most mature medical marijuana companies in the world, and Aurora Cannabis (NYSE:ACB) and Canopy Growth (NYSE:CGC) are the country's two largest players. Each of them generates meaningful medical marijuana revenue in Canada and Germany, and they're both establishing footprints in other markets, including Australia.

Canopy Growth works with 84,400 active registered patients (as of September 2018) and its medical marijuana market share exceeds 30% in Canada. Also, it gets about 10% of its revenue from medical marijuana exports to Germany. 

To maintain its leadership position in medical marijuana, the company was among the first growers to plan scientifically controlled clinical trials to prove cannabis' efficacy as a healthcare treatment. It had 15 trials planned or underway heading into 2019, including a phase 2b study of cannabis for the treatment of insomnia, which began in 2018.

Additionally, it has 39 U.S. provisional patent applications related to medical use of marijuana cannabinoids, and management's also launched Canopy Animal Health, a subsidiary dedicated to proving the effectiveness of cannabis in pet health. For instance, that subsidiary received approval to evaluate marijuana as a treatment for anxiety in certain animals in 2018.

Almost all of Canopy Growth's sales have come from medical marijuana in the past, but medical marijuana sales as a percentage of revenue are likely to fall as Canada's recreational marketplace matures. For perspective, recreational sales could top CA$4 billion in 2019, while medical marijuana sales may total only about CA$700 million, according to Deloitte.

The situation is similar at Aurora Cannabis. Its acquisitions of CannaMed and MedReleaf in 2018 significantly increased its active registered patients, and as of September 2018, Aurora Cannabis was working with 67,484 active registered patients, up 250% year over year.

Those acquisitions also bulked up Aurora Cannabis' pipeline of clinical-stage cannabis trials. It's completed or in the progress of completing 40 clinical trials or case studies, plus it has seven preclinical trials underway entering 2019. The various indications it's targeting include pain, cancer, epilepsy, PTSD, anxiety, opioid use, and neurodegenerative diseases.

Aurora Cannabis also claims to be the largest distributor of medical cannabis in Europe. It owns two cannabis production facilities that have met production and quality requirements for pharmaceutical-grade manufacturing, resulting in European Union good manufacturing practice (GMP) certification, and it owns a GMP-certified distribution facility in Germany. 

Like Canopy Growth, Aurora Cannabis will be a big participant in Canada's adult-use recreational market, but medical marijuana will remain an important contributor to this company's future, making it and Canopy Growth the top two growers every medical marijuana investor ought to consider.

Marijuana drug developers

Although the U.S. Drug Enforcement Agency is making it easier for Canadian makers to ship their medical marijuana extracts to the U.S. for research, those deliveries remain limited. As a result, investors interested in exposure to the U.S. medical marijuana market might want to consider buying shares in drugmakers that are developing marijuana medicines that can secure Food and Drug Administration approval and avoid obstacles caused by federal marijuana prohibition.

Historically, medical marijuana research in the U.S. has been hamstrung because the DEA licensed only the University of Mississippi to grow a limited supply of marijuana for use in studies. Because of that, the only significant marijuana-drug to win an FDA OK until 2018 was Marinol, a THC medication approved in 1985 for nausea and vomiting in cancer patients and anorexia in AIDS patients. At its peak, Marinol sales were above $200 million annually; however, the drug has since lost patent exclusivity and most of its sales are split among various generic drugmakers, making it less intriguing to medical marijuana investors.

However, in 2018 the FDA approved GW Pharmaceuticals' (NASDAQ:GWPH) Epidiolex, a CBD drug for epilepsy, making the company a pure-play marijuana drug developer investors can consider owning. A U.K.-based company, GW Pharmaceuticals has been researching medical marijuana since the 1990s. In the EU, it markets Sativex, a THC-derived medication for multiple sclerosis spasticity.

Sales of Sativex never took off, but Epidiolex commercial opportunity in the U.S. could be significant because epilepsy is a billion-dollar-per-year indication. Epidiolex has been approved only for use in Dravet syndrome and Lennox-Gastaut syndrome, two rare types of epilepsy, but it could become standard care in those indications. There are an estimated 30,000 to 35,000 patients in the U.S. with those two types of epilepsy, and unfortunately, most of them fail to respond to traditional antiepileptic medications. Epidiolex reduced seizures from baseline in these indications by between 40% to 50% in clinical trials, and because it's available by prescription, patients can take it in all 50 U.S. states, regardless of federal or state marijuana laws. Given Epidiolex's list price of $32,500 per year and an addressable patient population in the tens of thousands, Epidiolex could capture hundreds of millions of dollars in sales per year.

GW Pharmaceuticals' opportunity might not be limited to Epidiolex, either. It's also evaluating marijuana cannabinoids in other indications, including schizophrenia and autism. If cannabis can safely address those indications, it could represent billions of dollars in revenue opportunity for the company.

Top marijuana dispensary stocks

The top marijuana growers, including Aurora Cannabis and Canopy Growth, are opening stores and partnering with retailers in Canada, but if you're interested in medical marijuana retailers in the U.S., you have limited options because many dispensaries are privately owned, rather than publicly traded.

One of the exceptions is Medmen, a 16-store marijuana company that became publicly traded on the OTC market in 2018. Medmen's nine stores in California, the biggest medical marijuana market in the U.S., account for over 90% of its revenue.

Medmen has big expansion plans. The company has an agreement in place to buy a rival, PharmaCann, and once it has done that, it will have licenses allowing it to operate up to 76 stores in 12 states. The deal also increases Medmen's store count to 29. Overall, its management says that its existing licenses give it access to states accounting for roughly half of the expected $75 billion marijuana retail market in 2030. 

Green Thumb is another option for investors. It operates 13 dispensaries under the RISE brand in eight states, and it has licenses to open as many as 72 retail locations in nine U.S. markets. Its focus on heavily regulated markets that limit licenses could mean less competition, higher margin, and greater market share than other retailers.

Best industry vendors

If you're interested in companies likely to prosper from sales to fast-growing marijuana companies, suppliers could be a perfect investment alternative. Because these companies work with many cannabis companies, they're somewhat insulated against the risk of a single cannabis company going bankrupt.

The largest marijuana company supplier is Hawthorne, a supplier of greenhouse solutions, including hydroponics, owned by Scotts Miracle-Gro. Hawthorne has been acquiring smaller suppliers over the past few years to build up its product line and create more cross-selling opportunities. In fiscal Q4 2018, acquisitions allowed Hawthorne's revenue to grow 65% year over year to $152 million despite some recent headwinds.

Although Hawthorne is a major supplier likely to benefit from growing demand as more states legalize marijuana, it is exposed significantly to growers, and that means sales may fluctuate widely because of underlying commodity prices for marijuana dried flower. Last year, overproduction in maturing markets, including Colorado, Washington, and Oregon, caused marijuana commodity prices to tumble, reducing demand and thus sales at Hawthorne.

Nevertheless, Hawthorne has established itself as a leader in hydroponics, nutrients, and other solutions used by growers, and its scale and distribution experience suggest it will be a beneficiary of the long-term trend of rising sales because of legalization.

KushCo Holdings operates in a different market from Hawthorne, focusing primarily on packaging solutions, including bottles, tins, and vapes. Additionally, it acquired a brand marketing company last year, and it sells solvents and other solutions necessary for extracting marijuana's chemical cannabinoids. The company's acquisitions and organic growth resulted in sales of $52 million in fiscal 2018, up 177% from the prior year, and sales grew 186% year over year to over $25 million in the quarter ending November 2018. For fiscal 2019, KushCo Holdings thinks packaging, solvents, and other product sales will result in sales of about $115 million. 

The company supplies over 5,000 cannabis companies, and future growth could come from new recreational marijuana dispensaries in California, on the East Coast, and in Canada. That's important because California is the largest legal recreational marijuana market in terms of both population and sales. For perspective, quarterly sales in California grew 211% year over year to $13.9 million in the quarter ending November 2019. 

The risks of investing in medical marijuana

The medical marijuana market is more mature than the recreational, adult-use market, but that doesn't mean that investing in medical marijuana stocks is risk-free. Most of these companies have limited operating histories, and their growth prospects depend on marijuana prohibition's remaining out of favor. If pot prohibition regains momentum, the value of these stocks could fall, unless they're able to pivot and secure FDA approval that sidesteps enforcement actions.

There's also no guarantee that future trials conducted by medical marijuana companies will prove that marijuana is as safe and effective as it's currently believed to be. We've already seen some evidence of this risk. In 2015, GW Pharmaceuticals trials evaluating a THC-based medication in cancer pain patients failed to outperform a placebo.

Overall, legal marijuana markets are in their infancy, and countless companies are angling to capture a share of this massive market. Many of them, however, will fail, and that makes investing in marijuana stocks dangerous. There's a real chance of losing a significant amount of money if you're not careful, so it's critical to do your homework and understand these businesses before buying.

What's next for these stocks

Over $150 billion is spent on marijuana worldwide every year, according to the United Nations, and since most of that business is still being done on the black market, profit from legalization could rival that of the tobacco and alcohol markets, making marijuana stocks some of the most intriguing investments out there for growth-oriented investors. 

Furthermore, spending on medical marijuana could skyrocket in the coming years because marijuana companies are investing considerably to conduct scientific trials validating the use of their strains in various high-impact indications. If these trials allow companies to differentiate their marijuana from competitors' marijuana, it could provide a lot of margin-friendly pricing power that winds up rewarding investors in the coming decades.