Most industries, products, and markets that achieve broad public acceptance have been shown to follow a particular growth trajectory known as an “S Curve.” Essentially, early adopters touch off initial growth called the "infancy stage" in which the market slowly ramps up. As the offering becomes more popular, more and more people come on board, creating a period of heavy growth called the "expansion stage." After 75 percent penetration, the curve levels off in what is called the "maturity stage."

That second stage in the "S-Curve" is where the market provides the best returns as it begins to mature. After a time, that growth tapers off as the market becomes more saturated. The resulting plot takes on roughly the shape of an “S.”

Where is Cannabis On The “S Curve”?

So where does cannabis stand in this model of market expansion? An in-depth article in Streetwise Reports, written by Ron Struthers of Struthers Resource Stock Report, discusses recent trends in cannabis investing, plotting them on this “S Curve.”

In the report, entitled, The S-Curve Reveals It Is Early Days in the Marijuana Growth Cycle, Struthers suggests that the salad days are yet to come for the cannabis industry.

“A lot of the rage in 2017 and January 2018 was cryptocurrencies, blockchain technology and marijuana.” writes Struthers, who says he finds it very difficult to predict cryptocurrency and blockchain trends. “Marijuana markets on the other hand,” he says, “are far easier to analyze using typical new innovation trends and the tried and true 'S-Curve.’”

Cannabis S-Curve

When a new technology or innovation reaches about 5 percent market penetration, things begin to get interesting for investors. The most robust growth occurs in the middle of the curve where market penetration shoots up to between 50 percent to 75 percent.

Struthers points out that a market that jumps from 10 percent to 50 percent provides a 400 percent growth rate, while from 50 percent to 75 percent only offers a 50 percent growth rate. Therefore, “every market participant can do well in this strong initial growth phase,“ Struthers suggests.

From an investor's perspective there is always a wash out among the market players in a particular industry when you get over the half way mark in the expansion phase. I think of the "S" on its side and after a new technology or innovation obtains acceptance, the strongest growth occurs climbing up the first side of the S. Acceptance usually occurs around 5% market penetration and this first phase of growth will go somewhere between 50% to 75% market penetration. If a market goes from 10% to 50%, that is 400% growth rate while from 50% to 75% is only a 50% growth rate. Every market participant can do well in this strong initial growth phase and even the turkeys will fly.

For example, Struthers points to the PC, cell phone, and dot-com booms as examples. These markets, he says, achieved acceptance and saw very strong growth up until around 2000.

In February 1999, according to the article, home PC penetration hit 50 percent, almost doubling from 27 percent in 1995 - a period of just four years. That number rose to around 75 percent over the last several years - an increase of 50 percent over more than a decade and a half - quite a difference from the rapid pace of early growth.

“Once you get over that 50 percent penetration,” Struthers point out, “it is not long before you have a severe washout in that market as the growth slows and there are usually too many suppliers. From there, the strong survive and they become stronger as they pick up the pieces and the best parts of failures.”

To illustrate his points further, Struthers looks to Canadian LPs such as Canopy Growth Corporation (TSX:WEED) and Aurora Cannabis (TSX:ACB), showing that these companies are in the early part of the expansion phase.

Canopy Growth currently serves roughly one-third of the country’s 200,000 medical marijuana customers. Some 3 million Canadians are expected to use recreational marijuana next year. “Assuming [Canopy’s CEO] is an over-optimistic industry insider and we go with 2 million,” argues Struthers, “the current 200,000 is 10 percent of the market.”

I don't believe many are analyzing the marijuana market using innovation trends and the S-Curve, but it is not very difficult to do. I believe this will be of great benefit to investors if they have an idea where we are in the growth cycle of this market. The U.S. market has some challenges because it is segregated by different laws in different States, but Canadian laws are nationwide. The California marijuana market is around the same size of Canada's, so some similarities may be drawn there.

Canadian LPs Expected To Double Production In The Short Term

Canadian cannabis companies, according to Struthers, are on a steady growth spurt. There is also a lot of new production coming onstream, he says. Recently Canadian LPs have collectively raised nearly $2 billion for expansion. And in the last half of 2017, Health Canada handed out nearly double the number of production licenses. “Most expansion plans I see entail a doubling in production capacity. It does not matter what industry you are in, doubling production is no easy task,” he says.

Struthers' argument suggests that now is the time to invest for strong growth.

`In the U.S., The North American Marijuana Index showed strong performance in late 2017 and January 2018 rising from 120 in November to a high around 360 in January. A recent correction knocked 100 points off the index.

“After such a strong run-up, a correction was warranted and very healthy,” Struthers writes, adding, “I believe this correction provides another good entry point in this market.”

Struthers expects the first wave of washouts to begin around 2019.