After a recent stumble, the market has again rallied toward all-time highs. That's a pattern investors have gotten used to, buying the dips in the expectation of a swift return to gains. Someday those gains won't be so quick to come back -- but the real question investors should be asking about individual stocks is whether or not their unique fundamentals support their valuations. Often that's not the case, but for Innovative Industrial Properties (NYSE:IIPR), there's good reason to believe that dividend growth investors will find today's prices well worth paying.

Marijuana is the key

Innovative Industrial is a real estate investment trust (REIT) that invests in the marijuana sector using the net lease approach. There's a lot to unpack there.

First, REITs are specifically designed to pass income on to shareholders. On one side of the spectrum, some REITs have low yields so they can put cash to work growing the business, and on the other side some have high yields and low growth rates because most of the cash goes out the door to shareholders. Innovative Industrial is somewhere in between. It has grown swiftly and has a relatively modest 2.6% dividend yield at recent prices, but it has also rewarded income investors exceptionally well.

A cannabis grower inspects a plant.

Image source: Getty Images.

The marijuana REIT has increased its dividend annually since paying its first dividend in 2017. But the real shocker is that the dividend has increased from $0.15 per share per quarter to a huge $1.40. That swift dividend growth has not gone unnoticed on Wall Street, and it helps explain why investors have flocked to the stock. While it's unlikely that Innovative Industrial can continue to grow the dividend at the same clip forever, the most recent dividend represented a year-over-year increase of 32% with four increases in between. 

Even if that growth rate dropped down to "just" 10%, dividend growth investors would be well rewarded here. And, notably, an investor's yield on purchase price would grow very quickly. In other words, assuming that Innovative Industrial can keep growing, even if the rate slows down, the stock could be well worth a premium price for the right type of investor.

What's the outlook?

But can it really manage that feat? The answer is likely to be yes.

Innovative Industrial fills an important role for marijuana companies, which lack access to more traditional forms of capital like bank loans. That's because of the still tenuous legal issues around the drug. Innovative has, effectively, stepped in to provide much needed funding by buying properties from pot companies and instantly leasing them back. The seller is more than happy to pay a premium for this service because it gets cash to support growth. It is also happy to continue paying to maintain the properties (making them net leases) because of the unique nature of grow houses. Innovative, meanwhile, gets to sit back and collect rent, tapping the capital markets for more cash as it looks to ink additional deals.

As one of the first players in the space, it has leases with some of the biggest names in the marijuana industry. And that will likely provide it with key relationships that will support long-term growth even after banks are more willing to deal with marijuana companies. It may have to reduce its lease rates, but, as noted, a slowdown from today's rapid growth wouldn't be the worst thing given that current growth is so high. And it's worth noting that the REIT only owns around 70 properties, so it is still small enough that one-off deals can be meaningful.

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Meanwhile, Innovative Industrial estimates that legal marijuana sales in 2020 totaled around $20.1 billion. That's slightly more than 50% year-over-year growth compared to 2019. And the REIT is projecting the market to expand to nearly $46 billion by 2025. If that's close to the mark, there's plenty of opportunity for Innovative to keep expanding its portfolio and increasing its dividend.

The final call

If you have a value focus, you will want to bypass Innovative Industrial, perhaps putting it on your wish list for the next deep market downturn (which is impossible to predict). But if you have a dividend growth approach, then the company's strong history, solid business model, and ample growth prospects suggest it is worth a premium. In fact, waiting for a "cheap" price could mean missing out on material dividend growth and stock price gains if the dividend continues to expand as it has in the past. 

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.