Better Marijuana Stock: Aphria vs. Innovative Industrial Properties

Two very different kinds of marijuana stocks. Which is the smarter pick for long-term investors?

Direct or indirect? That's the choice when it comes to investing in either Aphria (APHA) or Innovative Industrial Properties (IIPR -0.17%).

Aphria is the direct option. The company ranks as one of the top marijuana growers in the world. Innovative Industrial Properties is a real estate investment trust (REIT) that focuses on the cannabis industry, making it more of an indirect marijuana play.

So far this year, Innovative Industrial Properties stock has performed significantly better than Aphria has. But which of these two marijuana stocks is the better pick now?

Image source: Getty Images.

The case for Aphria

There are three key arguments in favor of buying Aphria stock:

The global marijuana market is going to be huge.
Aphria has what it takes to succeed in this market.
Its stock is more attractively valued than many of its peers.

Let's look at each of these arguments in more detail. First of all, the global marijuana market is already huge. The United Nations estimates the size of the market at around $150 billion. The catch is that this figure includes illegal marijuana sales for recreational use. Currently, only two countries allow the legal sale of recreational marijuana -- Canada and Uruguay.

But increasingly, more countries have legalized medical marijuana, notably including Germany and the United Kingdom. Mexico could soon legalize recreational marijuana. The chances appear to be improving that the biggest market of all -- the U.S. -- might change its federal laws to allow states to make their own decisions about marijuana legalization.

So what does it take to succeed in this market? Capacity, distribution channels, and cash. Aphria appears to be in pretty good shape on all three counts.

The company is on track to claim the third-largest production capacity in the industry. Aphria expects its capacity will increase to 255,000 kilograms per year by early 2019.

As for distribution channels, Aphria has supply agreements for the recreational marijuana market with all of Canada's provinces plus the Yukon Territory. The company has a solid distribution partner for this market in Southern Glazer's, the largest wine and spirits distributor in North America. Aphria also has operations and partnerships that position it well in Europe, Australia, Lesotho, and South America.

The company reported cash and cash equivalents totaling 273 million in Canadian dollars as of Aug. 31, 2018. Once the Canadian recreational marijuana market kicks into full swing, Aphria should generate a solid cash flow.

Aphria's current market cap of $2.3 billion is well below several of its peers. Investors get a lot more production capacity for the dollar with Aphria stock than they would with most other major Canadian marijuana stocks.

The case for Innovative Industrial Properties

Why buy Innovative Industrial Properties (IIP) stock? Here are the top three reasons:

The global marijuana market is going to be huge.
IIP provides diversified exposure to the cannabis industry.
IIP could generate a very attractive total return over the long run.

We've already covered the first argument. However, unlike Aphria, IIP operates in the U.S. To be specific, the company has developed properties and leases to tenants in seven U.S. states: Arizona, Maryland, Massachusetts, Michigan, Minnesota, New York, and Pennsylvania. Three of these states are projected to have marijuana markets of more than $1 billion within the next four years.

IIP definitely has the opportunity to grow in these states and expand to other states. Thirty-one states have legalized medical cannabis, which is the market IIP focuses on.

Because of its business model, IIP provides more diversification than most marijuana stocks do. The company currently has nine tenants, and the weighted-average length of the leases for these tenants is around 15 years. As IIP grows, its diversification benefit will increase, as well.

As a REIT, IIP must pay out at least 90% of its pre-tax income as dividends. The company's dividend currently yields 3.15%. Over the long run, IIP's dividend should boost its total return considerably.

But the stock also could generate big gains. IIP already is profitable and looks relatively cheap compared to most marijuana stocks, with its shares trading at 24 times expected earnings. This valuation should give IIP stock more room to run than many marijuana stocks as the U.S. cannabis industry grows.