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2 Monster Stocks in the Making

Many stockholders invest in the hope of finding stocks that later deliver outsized returns. While investors can easily find fast-growth stocks in today's market, realistically, most growth names will not deliver returns comparable to those giants. Nonetheless, companies such as Innovative Industrial Properties (NYSE: IIPR) and Fastly (NYSE: FSLY) hold potential for massive increases as they lead segments within their fast-growing industries.

Image source: Getty Images.

Innovative Industrial Properties

Innovative Industrial is a unique take on real estate investment trusts (REITs): It acquires and leases facilities for cannabis production to marijuana companies. Grand View Research forecasts the U.S. cannabis market will grow at a compound annual rate (CAGR) of 27% through 2028. For this reason, the company has had no issues keeping its property portfolio 100% leased.

Additionally, it provides another essential need that smart investors know well. Due to federal restrictions on cannabis, marijuana growers cannot borrow money. Innovative Industrial helps growers sidestep this challenge through its sale-leaseback program, providing capital by buying a company's property and leasing it back to its previous owner.

This approach helped Q1 2021 revenue rise by 103% from year-ago levels to $43 million. By keeping cost growth below that of revenue, the company increased its net income by 122% to $26 million. During 2020, revenue surged 162% versus 2019 levels to $117 million. Since expenses grew by 140% during that time, net income rose 191% to $64 million.

Moreover, the annual payout now stands at $5.60 per share, a cash return of 2.7% at recent prices. And since REITs have to distribute at least 90% of their taxable income in the form of dividends, stockholders have benefited from the rising profits. As a result, this payout has increased in nine out of the last 10 quarters.

The company paid $32 million in dividends in Q1, $6 million more than its net income. But don't worry, that payout is sustainable. Net income includes non-cash deductions, such as depreciation, that can understate a REIT's performance. So REITs are typically evaluated using adjusted funds from operations, their real estate cash flow. Innovative Industrial brought in $38 million in AFFO in the first quarter; thus, current earnings can cover the dividend costs.

Investors have also profited from stock returns, as Innovative Industrial surged by more than 120% over the past 12 months at recent prices.

IIPR data by YCharts

Innovative Industrial faces one key risk in the form of federal legalization, a development that would make bank loans available to cannabis producers. This would give growers an additional option for raising capital and would likely lessen the appeal of the company's sale-leaseback program, a key source for property acquisitions.

Admittedly, this increased competition could slow revenue growth and bring some uncertainty to the stock. Nonetheless, 100% of its facilities remain leased, and it could still acquire new properties under such conditions. Given the industry's 27% CAGR, the company could probably generate significant growth even if producers start taking out more bank loans.

Fastly

As cloud services have become a bigger part of the economy, so have Fastly's edge computing services. Edge computing takes data from the cloud and brings it to a data center in closer proximity to a user's location. This functionality increases both the speed and reliability of cloud-based data from a user perspective. It also allows data providers to distribute data simultaneously across multiple locations.

Not surprisingly, large cloud companies such as Amazon and Microsoft offer edge services. And smaller companies such as Cloudflare and Akamai specialize in this area. However, despite a market cap of only $6 billion at recent prices, Fastly has found a way to compete with industry giants by allowing developers to build content delivery networks from scratch. Hence, companies can better configure their edge computing systems to their needs, helping to better facilitate faster speeds and real-time updates.

Increased demand for such services in 2020 amid the pandemic benefited Fastly. That year, Fastly's revenue climbed 45% from 2019 levels to $291 million. Still, losses nearly doubled during that time to $96 million as the company tripled its general and administrative expenses to hire more personnel. In 2021, growth slowed as revenue surged 35% versus the first quarter of 2020 to $85 million. Moreover, losses widened to $51 million from $12 million in the year-ago quarter as operating expenses and interest expenses doubled during that time.

Investors should expect robust but slower growth to continue. Fastly projects full-year revenue of $380 million to $390 million, an increase of at least 23%.

Nonetheless, the slowing revenue growth has weighed on Fastly stock. Although it has risen by almost 160% since the beginning of 2020, Fastly has dropped 60% from its peak in mid-October. Also, an earnings disappointment and a CFO departure contributed to the drop following the Q1 2021 earnings report in May.

FSLY data by YCharts

Still, the decline may present a buying opportunity for investors. Fastly recently traded at a price-to-sales ratio around 18. While that has risen from single-digit levels in March 2020, it is well off the peak sales multiple of 48 in October.

Indeed, competition from the biggest names in tech, mounting losses, and a falling stock price might deter some investors. Nonetheless, with the ability to stand out in the fast-growing edge computing market, Fastly could experience massive increases over time.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Will Healy owns shares of Innovative Industrial Properties. The Motley Fool owns shares of and recommends Amazon, Cloudflare, Inc., Fastly, Innovative Industrial Properties, and Microsoft. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.


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