Bigger sometimes can be better.

Canopy Growth Corporation (NASDAQ:CGC) currently ranks as the biggest pure-play marijuana stock, with a market cap of around $5.1 billion. Its size puts Canopy Growth well ahead of the No. 2 marijuana stock, Aurora Cannabis (NASDAQ:ACB), which claims a current market cap of around $4.3 billion.

But while Canopy Growth has the largest market cap, its valuation using one key metric makes the stock appear more attractive than any of the other four large Canadian marijuana growers -- Aurora, Aphria (NASDAQOTH: APHQF), Cronos Group (NASDAQ:CRON), and MedReleaf (NASDAQOTH: MEDFF). Here's how.

Tiny figures pushing wheelbarrows with marijuana buds on top of $20 bills

Image source: Getty Images.

A unique metric

One problem with determining the valuation of marijuana growers is that several of them don't have positive earnings yet. That means that common valuation metrics like price-to-earnings multiple have to be tossed out the window.

It's easier to use revenue-based valuation metrics like price-to-sales. The problem, however, is that sales are increasing so fast for many marijuana growers that historical price-to-sales multiples don't mean much. And predicting future sales for the companies isn't easy.

You could go old school and use the price-to-book ratio. But there's a drawback with that approach, too. The book value is calculated by subtracting liabilities from assets. There's a lot of fluctuation in the valuation of assets for marijuana growers.  

Because of these issues, I think there's another valuation metric that could be the best to use for the marijuana industry: market cap/annual production capacity. This metric should help give investors a pretty good comparison of how much bang for the buck they would get from different marijuana stocks. 

Determining production capacity

There's still a bit of a challenge with using the market cap/annual production capacity multiple for comparing marijuana stock valuations, though. While market caps are easy to find for each stock, determining annual production capacity for each company isn't as clear-cut as you might expect.

One reason why is that the dynamics in the Canadian marijuana industry are rapidly changing. All of the big players have been expanding internal capacity. Several have also added external capacity. For example, Aurora Cannabis recently acquired CanniMed Therapeutics.

Marijuana growing in greenhouse

Image source: Getty Images.

The bottom line is that the capacity of a marijuana grower now won't be the same as the capacity a year or more from now. That doesn't mean the market cap/annual production capacity metric can't be used, though. We just need to look out a couple of years to factor in planned expansions by marijuana growers. And we have to realize that acquisitions and partnerships could muddy the waters.

Canopy Growth also presents one other hurdle. While most marijuana growers provide details about their current and projected annual production capacity in terms of kilograms per year, Canopy doesn't. Instead, the company says that it's on track to have over 5.6 million square feet of domestic growing space. 

This isn't a show-stopper, though. We can use an expected yield of how much marijuana can be grown per square foot in a year to determine an annual production capacity for Canopy Growth. In 2016, Cannabis Business Times conducted research that found an average yield per square foot of 39.5 grams. If we assumed four harvests per year, that would translate to nearly 0.16 kilograms per square foot in annual production capacity.

Using this measure of yield, Canopy Growth's projected annual production capacity would be in the ballpark of 896,000 kilograms. Granted, that could be overly optimistic. For example, Cronos Group's expansion at its Peace Naturals location will result in a 286,000 square feet indoor facility with estimated annual capacity of 40,000 kilograms. That's a yield of close to 0.14 kilograms per square foot. If we used that yield for Canopy, the company's projected annual production capacity would be around 784,000.

Ranking the "big five"

So how do the "big five" Canadian marijuana stocks compare using the market cap/annual production capacity metric? Here's how they stack up -- again, with the disclaimer that projected annual production capacity is a very fluid number.

Company Market Cap Projected Annual Production Capacity (kg/year) Market Cap/Annual Production Capacity
Canopy Growth $5.1 billion 784,000 ~$6,450
Aphria $1.8 billion 230,000 ~$7,770
MedReleaf $1.4 billion 140,000 ~$9,730
Aurora Cannabis $4.3 billion 283,000 ~$15,200
Cronos Group $1.2 billion 71,000 ~$16,700

Data sources: Yahoo! Finance, company news releases, and investor presentations. Calculations by author. 

At least based on the market cap/annual production capacity metric, Canopy Growth is the most attractively valued of the biggest Canadian marijuana growers. In general, higher market caps and annual production capacity translated to lower valuation multiples.

Aurora Cannabis was the lone exception. It's not surprising that Aurora has also enjoyed the best stock performance of the group over the past 12 months -- nearly quadrupling in value.

One potential flaw

There's at least one potential flaw with using the market cap/annual production capacity multiple. The measure assumes that higher production capacity is associated with higher sales and earnings potential. That could be the case, but only if demand exceeds supply.

For example, let's assume for a minute that the marijuana market for these companies was limited to Canada. Mackie Research Capital estimates that total demand for marijuana in Canada for 2018 will be around 795,000 kilograms. If this level of demand held steady, Canopy Growth's projected capacity would almost be enough to supply the Canadian market all by itself. In this scenario, Canopy Growth's enormous projected capacity probably wouldn't translate to higher sales and earnings power -- at least not all of the capacity. 

Of course, in the real world the global marijuana market isn't limited to Canada. And the marijuana growers can't grow as much marijuana yet as they're projecting they'll be able to in the future. For now, at least, using market cap/annual production capacity appears to be a reasonable way to compare valuations of marijuana stocks. Canopy Growth is the biggest of these stocks -- and it's the biggest value as well.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.