It May Look Pricey, But This Profitable Cannabis Stock Can Still Make You Rich

The cannabis industry is booming, but that doesn’t mean every player in the space is destined for success. As global legalization progresses and consolidation — such as the upcoming AphriaTilray merger — continues, we will see a group of deep-pocketed players coming to compete for a finite number of dollars. Currently, many of the biggest companies, Tilray among them, are experiencing…

ballooning losses because of lower gross margins, unfavorable inventory valuation adjustments (presumably due to ] cost-cutting spurred by competition), and high sales, marketing, and research costs.

Such losses are not uncommon in commodities or industries that mimic commodities, because traditionally, there are no moats protecting a commodity producer. In the case of a marijuana distributor or grower, what is to prevent any other player — legal or otherwise — from slashing prices to the bone to starve its rivals of profit?

The other side of the statement

Is it possible that the best way to play this trend, currently, is from the cost side of the industry’s income statements? After all, pure-play cannabis players seem to have no problem growing revenue; Tilray’s sales rose by 25% in just the past year. And there’s one absolutely necessary expense for each of these companies: rent. A revolutionary real estate investment trust (REIT) called Innovative Industrial Properties (NYSE:IIPR) is taking advantage of this situation with an experienced management team comprised of leaders who co-founded multiple other REITs. (REITs have a special legal structure which requires them to distribute 90% of the income they generate back to shareholders and invest 75% of their assets in real estate.)

Innovative Industrial Properties offers triple net lease properties, meaning that the tenant pays the cost of taxes, insurance, repairs, and other costs, to fully licensed medical marijuana distributors. Unlike the pure-play marijuana stocks, Innovative Industrial Properties is profitable right now, and its net income was up 163% in 2020.

So what’s the catch?

When I hear friends in the investment industry criticize Innovative Industrial, it’s usually not on the basis of the company’s business model, which is sound, or its moats, which are wide and growing (as I’ll go into momentarily). Rather, the elephant in the room is valuation.

It’s undeniable that compared to the market average, Innovative Industrial is expensive. Its current price-to-earnings ratio (P/E) of 55 is more than double that of the S&P 500. Even compared to other REITs, it’s pricey. But in the context of the company’s own history, in which the P/E has ranged between 25 and 280, the current level is cheap — even below the median of 60.

And I’d argue that this is how it is supposed to work. Stock price appreciation has two components, one of which is…

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