Within four years the global medical marijuana market is projected to more than double from 2018 levels, according to estimates from Arcview Market Research and BDS Analytics. That's a market of over $11 billion ripe for the picking for companies that are ready for the challenge. 

But what does it take to succeed in the medical marijuana industry? And which stocks are most likely to profit from the industry's growth and are smart picks for investors? Here's what you need to know about the top medical marijuana stocks to buy in 2019.

Marijuana buds and bottle on top of prescription pad

Image source: Getty Images.

Dynamics of the medical marijuana industry

There are two important dynamics of the medical marijuana industry that investors need to understand before buying any medical marijuana stock. First and foremost are the markets that are currently available.

Several countries have legalized medical marijuana at the national level. Canada claims the biggest market among these countries, with estimated sales of medical cannabis in 2018 of more than $600 million. Germany, however, is likely to overtake Canada as the most important national medical marijuana market within the next few years because of its larger population and wide availability of access.

Marijuana remains illegal at the federal level in the U.S. However, 31 states have legalized medical marijuana, with Missouri and Utah voting to legalize medical marijuana in the November 2018 elections. Total medical marijuana sales in 2018 are estimated to be around $4.3 billion and then jump even further to $7.7 billion by 2022.

Although California claims the largest marijuana market in the U.S. with Colorado ranking second, both states have much larger recreational marijuana markets. Florida is on track to have the largest medical cannabis market in the country with projected sales of $1.7 billion by 2022. 

Another dynamic of the medical marijuana industry is the types of products that are marketed. Medical marijuana can be inhaled by smoking dried flower or vaping concentrates, taken orally through oils or edible products (including beverages), or applied topically using cannabis-based creams and lotions.

The two most important ingredients in cannabis used for medical purposes are cannabidiol (CBD) and delta-9 tetrahydrocannabinol (THC). While many patients use CBD products, currently only one CBD-based drug has received U.S. Food and Drug Administration (FDA) approval -- Epidiolex. GW Pharmaceuticals obtained FDA approval in June 2018 for the CBD drug in treating Dravet syndrome and Lennox-Gastaut syndrome (LGS), both of which are rare forms of epilepsy. 

Three drugs containing THC have also been approved by the FDA. Marinol, Cesamet, and Syndros won regulatory approval for treating chemotherapy-induced nausea and vomiting for cancer patients. Marinol and Syndros also received FDA approval for the treatment of AIDS-related anorexia. All three of these drugs are made synthetically, however, rather than from the cannabis plant, like Epidiolex is made from. 

Types of medical marijuana stocks

There are three basic categories of pot stocks that focus on the medical marijuana industry:

  1. Marijuana producers
  2. Cannabis-focused biotechs
  3. Ancillary products and services providers

Marijuana producers set up greenhouses or indoor facilities where they cultivate plants, which they harvest and then process into products that are distributed to dispensaries, which ultimately sell to patients, or medical marijuana users.

Cannabis-focused biotechs develop medicines like prescription drugs that are made from the chemical ingredients of cannabis (known as cannabinoids). Some biotechs extract cannabinoids from cannabis plants while others manufacture the cannabinoids synthetically.

Ancillary products and services providers support the other types of medical marijuana businesses by providing products and services that are needed to do business. These products and services can range from consulting and administrative services to distribution to fertilizers, hydroponics (growing plants in water), and lighting systems used in cannabis cultivation.

What to look for in medical marijuana stocks

In evaluating whether a medical marijuana stock will deliver exceptional returns in the long-run, investors should consider many of the same attributes as they would for any publicly traded stock: Financial status, growth opportunities, and competitive position.  

Many medical marijuana companies aren't yet profitable. While that shouldn't disqualify these stocks from consideration for inclusion in your portfolio, the companies should have a defined plan for achieving profitability in the future. When companies aren't profitable, their cash position is more important because they might need to to raise additional capital through taking on debt or by issuing new shares.

The problem with increasing debt is that it could negatively impact future earnings if the amount of debt is too high. The primary issue with issuing new shares is that it could cause dilution in the value of existing shares. 

One way to think of dilution is to imagine the value of the company as a pie. Issuing new shares is similar to cutting the pie into more pieces. If you had one of the pieces of the pie initially, cutting the pie into more pieces means that your piece will be smaller. That's what happens with stock dilution.

Growth opportunities can vary significantly between different medical marijuana stocks. That's especially the case when companies are limited in which geographical regions they can compete. For example, some Canadian stocks can't establish significant operations in the U.S. and retain their listings on major stock exchanges while marijuana remains illegal at the federal level in the U.S.

Determining the competitive position of a medical marijuana stock isn't significantly different from doing so for other industries. Important factors to consider are production capacity (for medical marijuana producers), distribution channels, and partnerships.

Top medical marijuana stocks for 2019

Five medical marijuana stocks that score well on the three key evaluation criteria and appear to be top picks to buy in 2019 are:

Stock

Type

Market Cap 

Canopy Growth (NYSE:CGC)

Marijuana producer $10.6 billion

Innovative Industrial Properties (NYSE:IIPR)

Ancillary products/services provider $518 million

KushCo Holdings (NASDAQOTH:KSHB)

Ancillary products/services provider $439 million

Liberty Health Sciences (NASDAQOTH:LHSIF)

Marijuana producer $257 million

OrganiGram Holdings (NASDAQOTH:OGRMF)

Marijuana producer $481 million

Data source: Yahoo! Finance. Market caps as of Dec. 17, 2018.

Canopy Growth

Canopy Growth ranks as the largest marijuana producer in the world by market capitalization -- the total value of the company's outstanding shares. This can be found by multiplying the current price of the stock and the number of shares outstanding on the market. Canopy Growth serves the Canadian medical and recreational marijuana markets and distributes medical cannabis to multiple international markets, notably including Germany.

Although Canopy isn't consistently profitable at this point, the primary reason is that the company continues to invest in building its operating platform and in expanding. For example, Canopy has increased its growing space, made acquisitions to add to its brands and retail capabilities in Canada, and bought businesses to further establish its international operations. With significant growth in global marijuana markets, Canopy should be on a path to generate profits in the future.

Further expansion will require money -- but raising capital won't be an issue for Canopy Growth. The company has a huge cash stockpile thanks to a $4 billion investment by Constellation Brands, the maker of premium beers, wines, and spirits. 

Canopy has multiple paths for growth. There's continued expansion of global medical marijuana markets. Canopy is already a leader in the Canadian and German medical marijuana markets and has the resources to become a major player in other important new markets such as the United Kingdom. And Canopy is poised to profit as the Canadian recreational marijuana market takes off, especially when sales of cannabis-infused beverages are allowed in the country (probably in the second half of 2019).

The biggest knock against Canopy Growth is that it can't currently compete in the huge U.S. market. However, the legalization of hemp -- cannabis with very low levels of THC -- in the U.S. could open the door for Canopy to work with its partner, Constellation Brands, in launching hemp-based CBD beverages for the U.S. -- a market that could reach $22 billion by 2022.

The company is one of the top two marijuana producers in terms of annual production capacity. Canopy claims strong global distribution channels with subsidiaries, joint ventures, and partners that can market its products in countries across the world. And its partnership with Constellation, along with the cash the deal generated, gives Canopy a big advantage over its peers in making acquisitions to cement its leadership position within the cannabis industry.

Innovative Industrial Properties

Innovative Industrial Properties is the leading real estate provider of the U.S. medical cannabis industry. The company is organized as a real estate investment trust (REIT)

REITs present an attractive option for investors to profit from growth in the medical marijuana market because their risk is spread across multiple tenants. Further adding to the attractiveness of REITs, the government mandates that REITs must distribute at least 90% of taxable income to investors in the form of dividends.The good news is that Innovative Industrial Properties has plenty of taxable income to distribute. It has been profitable throughout 2018. The company's dividend currently yields 2.7%. Innovative Industrial Properties has no debt and a solid cash position.

Innovative Industrial Properties currently owns properties that are leased to tenants in eight states: Arizona, Colorado, Maryland, Massachusetts, Michigan, Minnesota, New York, and Pennsylvania. Importantly, four of these states are expected to have marijuana markets (including recreational marijuana sales in some states) of over $1 billion by 2022

The company's growth prospects include opportunities to build its customer base in the states where it currently operates. Innovative Industrial Properties also could expand into additional states in the future.

Other REITs could be attracted to the rapidly growing U.S. cannabis market. However, Innovative Industrial Properties has a head start in developing the expertise needed to develop properties for medical cannabis businesses, which gives the company a competitive advantage. 

KushCo Holdings

KushCo Holdings is the top supplier of packaging solutions to the U.S. cannabis industry. Its products include packaging solutions designed specifically for cannabis products, including pop-top bottles, vaporizer cartridges, tubes, and other containers. KushCo also makes hydrocarbon gases and solvents used in extracting cannabinoids from marijuana plants to make cannabis oils and other products. 

The company isn't consistently profitable at this point. However, its revenue is growing by leaps and bounds -- in part fueled by acquisitions. Still, KushCo will likely need to raise more cash in the near future and could issue more shares, causing dilution. As discussed earlier, dilution is a significant issue because it causes the value of existing shares to drop.  

But KushCo's growth opportunities should be able to get the company on a solid trajectory toward profitability. KushCo should benefit from the expansion of the U.S. marijuana market -- including both medical and recreational marijuana. The company also has significant growth opportunities in Canada and Europe. 

In addition, KushCo's acquisitions open up new markets for the company. Its buyout of Summit Innovations in May 2018 enabled KushCo to enter the hydrocarbons and solvents market. The company also acquired Zack Darling Creative Associates with its subsidiary, The Hybrid Creative, a move that gives KushCo an opportunity to grow through providing brand, marketing, and e-commerce services to the cannabis industry.

KushCo's expansion into adjacent markets helps insulate the company against competitive pressure from any larger packaging giants entering the space. In addition, KushCo's close relationships with its customers should enable it to develop packaging solutions that meet customers' needs effectively -- another big plus in fending off competition.

Liberty Health Sciences

Liberty Health Sciences is a medical marijuana producer headquartered in Canada but it has its primary operations in Florida. The company also operates medical cannabis dispensaries in the Sunshine State.

Like many cannabis companies, Liberty isn't yet profitable. However, the company should have enough cash to fund operations throughout most of 2019 and potentially beyond. Liberty Health Sciences should also make significant progress toward profitability as the Florida medical cannabis market matures.

Florida should soon claim the largest medical marijuana market in the U.S. and Arcview Market Research and BDS Analytics project that the state's medical marijuana sales will total $1.7 billion by 2022. Liberty Health Sciences currently claims around 15% of the Florida medical marijuana market, according to CEO George Scorcis. And Scorcis thinks that the company's market share will increase to around 25% as it expands its production capacity and launches new dispensaries. Florida alone should give Liberty Health Sciences solid opportunities for growth. However, the company is also planning to expand into other states with strong medical cannabis markets in the near future. 

One great thing about Liberty Health Sciences' presence in Florida is that the state only allows 14 entities to hold licenses for medical cannabis production and distribution. This means that Liberty's competition is relatively limited. With the company's growing market share and new dispensaries, Liberty Health Sciences should be in a solid competitive position in the years ahead.

OrganiGram Holdings

OrganiGram is, like Canopy Growth, a Canadian marijuana producer. The company is much smaller than Canopy but still ranks in the top seven producers in terms of projected annual production capacity. Unlike many of its producer peers, OrganiGram is profitable.

A key for the company's profitablity is its low operating costs. OrganiGram also claims a healthy cash stockpile, which means there's enough cash, cash equivalents, and short-term investments to fund operations at current spending levels for nearly four years. 

OrganiGram's growth prospects start at home in Canada. The company lined up supply agreements for the recreational marijuana markets in most of Canada's provinces, including two of the three biggest ones -- Ontario and British Columbia.

But OrganiGram's growth isn't limited to the domestic market. The company hopes to leverage its partnership with Alpha-Cannabis Pharma to become a major player in the German medical cannabis market. OrganiGram also acquired an interest in Serbian hemp producer Eviana and has teamed up with CannaTrek to supply Australia with medical cannabis.

OrganiGram certainly has stiff competition in Canada and in other countries. However, its valuation is more attractive than many of its rivals. For example, OrganiGram's price-to-sales ratio (share price divided by sales per share) of 51 is high relative to many stocks but is much lower than most marijuana stocks. And OrganiGram's cost advantages could help it compete effectively over the long run.

Risks for medical marijuana stocks

Perhaps the greatest risk for each of these medical marijuana stocks is that the markets don't expand as quickly as expected. Fewer countries could legalize medical marijuana than was projected. Strict regulations could be placed on the medical marijuana markets and patients may seek alternative treatments.  If that happens, the stocks would likely plunge because share prices are based more on significant expectations of future growth than they are historical performance.

The companies that operate in the U.S. -- Innovative Industrial Properties, KushCo Holdings, and Liberty Health Sciences -- face the possibility that the federal government could intervene in states that have legalized marijuana. That threat appears to be lower now, however, due to the forced resignation of former Attorney General and vocal marijuana opponent Jeff Sessions

Risks common to any stock regardless of the industry also apply to each of these medical marijuana stocks. Accounting issues, scandals involving executives, and competitive threats could hurt any of the stocks.

Due to its risky and novel nature, investing in marijuana stocks isn't suitable for all investors. Only the most aggressive investors are best suited for investing in medical marijuana. This means people who can afford to lose the money they invest in these stocks and don't need returns from their position for at least three or five or ten years. And even these investors should proceed cautiously in 2019 by limiting the size of their positions in medical marijuana stocks and diversifying across other industries. 

Long-term prospects

Overall, the long-term prospects of the medical marijuana industry appear to be very good. More countries and U.S. states are recognizing the potential benefits of medical cannabis and, as a result, allowing the legal use and sale of medical cannabis products. More individuals and the broader medical community are also recognizing these potential benefits, driving higher demand for medical marijuana.

Canopy Growth, Innovative Industrial Properties, KushCo, Liberty Health Sciences, and OrganiGram certainly face risks. However, each of these stocks appears to be in a good position to benefit from healthy growth in the medical marijuana industry. 

Keith Speights has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands, Innovative Industrial Properties, KushCo Holdings, and OrganiGram Holdings. The Motley Fool has a disclosure policy.