The global medical marijuana market is projected to expand by a compound annual growth rate (CAGR) of 22.4% through 2024, according to ResearchandMarkets.com. That's a market of more than $44 billion that's ripe for the picking. Much of this growth will be in the U.S., where 33 states have already legalized medical cannabis and more are on the way. Medical cannabis products sold in the U.S. include dried flower, vaping concentrates, cannabis-infused edibles, and topical products such as lotion.

But 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 investing in medical marijuana.

Marijuana buds and bottle on top of prescription pad.

Image source: Getty Images.

How to invest in medical marijuana stocks

One way to gain exposure to medical marijuana stocks is to buy a cannabis-focused exchange-traded fund (ETF), which is bought and sold like an individual stock but holds multiple stocks like a mutual fund. The primary advantage is that your money is spread across a basket of stocks, providing downside protection to your investment if one stock plunges. The negatives to investing in cannabis ETFs include annual expense fees that eat into your returns and the possibility that your money will be invested in stocks you don't like.

Investors who opt to buy individual medical marijuana stocks can choose Canadian or U.S. stocks. Because marijuana is illegal at the federal level in the U.S., companies with operations that violate those laws can't be listed on the major U.S. stock exchanges. However, their stocks are traded on less regulated over-the-counter (OTC) markets and, in some cases, on smaller Canadian stock exchanges.

There are five categories of pot stocks in the medical marijuana industry:

  • Growers: These cultivate cannabis plants that they harvest and process into products for distribution and sale.
  • Distributors and dispensaries: Distributors give medical cannabis products produced by growers to dispensaries, which sell the products to patients.
  • Extraction services providers: These extract from cannibis plants chemical ingredients (called cannabinoids) such as CBD and THC, which are used in medical cannabis products.
  • Drug developers: These are cannabis-focused biotechs and pharmaceutical companies that develop medicines made from cannabinoids.
  • Ancillary products and services providers: These support medical marijuana businesses by selling supplies and services they need.

What to look for in medical marijuana stocks

Investors should consider the same key attributes for medical marijuana stocks that they would for any stock:

  • Financial status: Many medical marijuana companies aren't yet profitable. While that shouldn't disqualify these stocks from 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 raise capital by taking on debt or issuing new shares, which can hurt the stock.
  • Growth opportunities: Growth prospects vary widely, especially when companies are limited by their geography. For example, some Canadian companies can't establish significant U.S. operations and retain their listings on major stock exchanges due to marijuana use being illegal on the federal level in the U.S.
  • Competitive position: Determine their economic moat by researching production capacity (for growers), distribution channels, and partnerships.

Top medical marijuana stocks

Five medical marijuana stocks that score well on the three key evaluation criteria and that investors might want to consider buying are:

Stock

Type

Market Cap

Canopy Growth (NYSE:CGC)

Grower $6.1 billion

Valens (OTC:VLNCF)

Extraction services provider $246 million

GW Pharmaceuticals (NASDAQ:GWPH)

Drug developer $3.8 billion

Trulieve Cannabis (OTC:TCNN.F)

Distributor and dispensary $1.4 billion

Innovative Industrial Properties (NYSE:IIPR)

Ancillary products/services provider $1.8 billion

Data source: Yahoo! Finance. Market caps as of June 15, 2020.

Canopy Growth

Canopy Growth serves the Canadian medical and recreational marijuana markets and distributes medical cannabis to international markets, including Germany. The biggest knock against Canopy Growth is that it can't yet compete in the huge U.S. medical cannabis market.

The company isn't consistently profitable. However, Canopy has a strong cash position thanks to a $4 billion investment by alcohol giant Constellation Brands.

Canopy has strong global distribution channels with subsidiaries, joint ventures, and partners that market its products around the world. Its ties to Constellation, along with the cash the deal generated, gives Canopy a big advantage in cementing its leadership position within the cannabis industry.

Valens

Valens is a Canadian cannabis extraction services provider that has multiyear extraction agreements with Canadian growers, including Canopy Growth, HEXO, OrganiGram, and Tilray.

The company is profitable and enjoys strong revenue growth. Medical cannabis extraction in Europe, Australia, and Latin America presents great growth opportunities. Its top opportunity now, though, is the second phase of Canada's recreational marijuana market, which allows the sale of cannabis derivatives such as vapes and edibles.

Valens' contracts with top growers and its claims to have the largest extraction capacity give it a competitive edge over rivals.

GW Pharmaceuticals

GW Pharmaceuticals is the largest cannabis-focused drug developer. The company's first drug, Sativex, is approved in multiple countries for treating spasticity associated with multiple sclerosis but isn't yet approved in the U.S. But GW's most successful product, CBD drug Epidiolex, is approved in the U.S. and in Europe.

GW remains unprofitable, but that should change soon. The drugmaker's revenue continues to soar thanks to strong demand for Epidiolex and its improving bottom line.

Epidiolex is its primary growth driver and should pick up tremendous momentum in key European markets. GW also hopes to win regulatory approvals in the U.S. and in Europe for additional indications.

Trulieve Cannabis

Trulieve Cannabis is a vertically integrated U.S.-based cannabis company that grows medical cannabis and distributes products to its retail dispensaries. The company's primary operations are in Florida, where it runs nearly 50 medical cannabis dispensaries. Trulieve also has operations in California, Connecticut, and Massachusetts.

Unlike most of its peers, Trulieve regularly delivers quarterly profits. The company's earnings growth remains strong, and Trulieve boasts a solid financial position with a growing cash pile.

Florida's medical marijuana market is in its early stages and presents a major growth opportunity. The company also hopes to expand in the U.S. and leverage its initial operations in other states that have fast-growing medical marijuana markets.

Innovative Industrial Properties

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

REITs present an attractive option because their risk is spread across multiple tenants. Even better, the government mandates that REITs must distribute at least 90% of their taxable income to investors in the form of dividends. Innovative Industrial Properties has plenty of taxable income thanks to its consistent profitability. 

Innovative Industrial Properties owns properties that are leased to tenants in 15 states. The company's growth prospects include opportunities to build its customer base in the states where it already operates and to expand into additional states.

The future of medical marijuana

The medical marijuana market faces several risks. Stricter regulations could be imposed. Markets might not expand as quickly as expected. There's also a distinct, albeit small, possibility that the U.S. government could intervene in states that have legalized medical cannabis to enforce federal laws.

Despite the risks, the long-term prospects of the medical marijuana industry appear very good. More countries and U.S. states are recognizing the potential benefits of medical cannabis and are 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. This presents a terrific opportunity for risk-tolerant investors.