Cannabis stocks have largely been getting clobbered in 2020, because of both the coronavirus-driven market sell-off and growing pains within the young industry. However, there's still reason to believe there will be at least a couple of big longer term winners among the group.
The legalization movement seems poised to continue to make steady progress. The number of U.S. states giving the green light to marijuana for medical and recreational purposes should continue to increase. In fact, the COVID-19 pandemic could accelerate this process. The crisis is going to leave many states hurting financially, and the tax revenue they could generate from legalizing marijuana is going to be looking mighty attractive.
Eventually, it seems probable that the substance will be legalized on a federal level in the United States and in other countries, too.
Cannabis stocks aren't for all investors as the group is volatile and risky. But for those who want exposure to the space, the best stock to consider buying now is Innovative Industrial Properties (IIPR -0.82%), a cannabis-focused real estate investment trust (REIT).
Image source: Getty Images.
Major cannabis stocks: Key stats
Context is important. So before we dive into Innovative Industrial Properties, or IIP, here's how its stock stacks up on some key metrics to the stocks of the largest three cannabis growers by market cap. All three are based in Canada, while IIP is a U.S. company.
|
Company |
Market Cap |
Profitable on a TTM Operating Basis? |
YTD 2020 Return (Loss) |
3-Year Return (Loss) |
|---|---|---|---|---|
| Innovative Industrial Properties | $1.3 billion |
Yes |
4.7% | 383% |
| Canopy Growth | $5.6 billion | No | (24.1%) | 140% |
| Cronos Group |
$2.1 billion |
No |
(22.6%) | 201% |
| Aurora Cannabis | $972 million | No | (65.7%) | (61%) |
|
S&P 500 |
-- | -- | (9.3%) | 29.7% |
Data sources: Yahoo! Finance and YCharts. Data as of April 30, 2020. TTM = trailing 12 months. YTD = year to date.
Innovative Industrial Properties' business
IIP buys properties in U.S. states where medical marijuana is legal and leases them to state-licensed operators using long-term, triple-net leases. It owned 51 properties located in 15 states, which were 98.9% leased (based on square footage), as of the release of its fourth-quarter 2019 results on Feb. 26. Most of these properties are industrial and used for growing and processing cannabis, though there are several retail properties in its portfolio.
Why Innovative Industrial Properties is the best cannabis stock
There are two key reasons why IIP stands out from others in the cannabis group: It's profitable, a rarity in the space, and it pays a dividend. It's the only cannabis stock, at least the only pure play, that pays a dividend, I believe. These two factors make the stock less risky than most other marijuana stocks.
In 2019, IIP's revenue rocketed 202% year over year to $44.7 million, driven primarily by acquisitions, though rental increases contributed. Net income soared 293% to $22.1 million, which translated to earnings per share (EPS) increasing 171% to $2.03. Adjusted funds from operations (AFFO) surged 259% to $34.9 million, which translated to AFFO per share rising 144% to $3.27. (FFO is a key watched metric for REITs, as it's the driver of dividend changes.)
IIP's dividend is yielding approximately 5%. As long as the company remains profitable, investors can count on it paying a dividend. REITs are required to pay out at least 90% of their taxable income each year as dividends to shareholders in return for their special tax treatment.
IIP has a unique tailwind: U.S. companies directly involved with marijuana have a difficult time obtaining financing from traditional sources, such as banks, because the substance isn't legal on the federal level. IIP's lease-buyback transactions provide cannabis operators with cash that they can use to grow their business.
Marijuana's legalization on a federal level has the potential to put a dent in the company's profitability because that event will increase funding options for cannabis operators. That said, there are many successful REITs in other industries, so there's no reason to believe IIP won't still have the potential to be quite successful over the long haul.
Wall Street expects IIP to grow earnings nearly 88% this year and more than 44% next year. Shares are trading at 20 times forward earnings, an attractive price assuming the company can continue to post solid profitable growth.
IIP should continue to be less volatile and risky than others in the cannabis group. But the space in general is volatile and risky, so keep this in mind when making investing decisions.
