3 Reasons Canopy Growth Could Burn You – Investorplace.com

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There are two ways bulls can play a stock like marijuana producer Canopy Growth (NYSE:CGC) … The first option simply is to buy CGC stock and hold it. From that standpoint, the long-term case — that Canopy will be a leader in a growing, worldwide marijuana industry and Canopy Growth stock will rise as a result — is worth riding out any volatility over the near term.

The second option is to trade that volatility. Even if the long-term case holds, the near-term price matters. Considering that Canopy Growth stock has gone from $25 to $55-plus, to $25 again and then back $50 in a six-month span, patient investors can try and time the stock to get the best possible price.

The issue for CGC stock, back near $50 even after some recent weakness, is that both methods at the moment suggest caution, if not outright skepticism. CGC’s huge gains of late — the stock already is up 73% year-to-date (YTD) — suggest profit-taking could be on the way. And for investors focused solely on the long-term, an $11 billion valuation already incorporates quite a bit of success.

I still think CGC is one of the most attractive stocks in the sector, and I liked CGC closer to $30 back in October. But there remain echoes of the dot-com bubble in pot stocks, and any stumble in the broad market could lead to yet another reversal in the sector. Ahead of Canopy Growth earnings next week, investors should be particularly careful not to get burned.

Reason #1: CGC Stock Needs Outside Help

As noted, Canopy Growth stock has been on quite the roller-coaster ride over the past few months. But it’s difficult to disentangle the sentiment toward CGC (and other pot stocks) from investor sentiment toward stocks more broadly.

After all, CGC’s plunge from mid-October highs near $60 wasn’t driven by any real company-specific news. There was a “sell the news” event as Canada legalized recreational marijuana on Oct. 17. But it’s not as if Canopy Growth earnings missed expectations or the long-term expectations for pot changed notably.

Rather, investors simply moved away from risk. And CGC, as a result, lost more than half its value in a little over two months. As market optimism returned toward the end of 2018, Canopy Growth shares rallied — and in fact doubled.

Already, there are some signs of cracking, as CGC has pulled back in recent sessions. It’s not difficult to imagine another reversal coming in the next few months, if not the next few weeks. U.S. stocks, on the whole, are up nicely in 2019, but it does feel a bit like a bear market rally rather than the beginning of a new uptrend. If that’s the case, CGC could tumble once again.

Reason #2: Canopy Growth Stock Lacks a Catalyst

Whatever the broad market does, after the YTD rally, CGC stock needs something to move it even higher. And I’m not sure what that’s supposed to be.

Canopy Growth earnings are on the way next Thursday, but they’re not necessarily likely to move the stock. The near-$11 billion market capitalization here is based on potential profits next decade and beyond. Strong growth in a single quarter isn’t really changing the story here.

Earnings in November did seem to hurt CGC stock, which fell into and out of the report. But that’s kind of the point: there’s so much priced in here that a single quarter can’t move the stock.

What will move the stock is big, sector-wide news. And it’s tough to see what that could be. U.S. legalization is the obvious mover … but it’s difficult to imagine any movement on that front for some time. Canopy already has received its multi-billion dollar investment from Constellation Brands (NYSE:STZ,STZ.B). Cronos Group (NASDAQ:CRON) has tied up with Altria (NYSE:MO). There may not be a third giant on the way.

So what changes the long-term story here? It’s difficult to see, beyond incremental movement in Canada. In terms of Canopy Growth and its industry, it’s difficult to imagine a piece of good news that isn’t already part of the story here.

Reason #3: The Valuation Has Moved Higher

One of the reasons CGC stock looked intriguing under $35 was because investors were getting a discount to what Constellation had paid for Canopy Growth stock. The beverage giant invested in CGC at $37 per share, though with additional warrants the effective price was closer to the low-$30s.

Still, there was an obvious bull case at those levels. A hugely successful (Constellation stock is a multi-bagger this decade) company had opened the Canopy Growth books, done its due diligence and decided to buy shares at more than $30. Shouldn’t an investor — any investor — do the same just a few months later?

At $46, however, that argument is moot. In fact, it looks potentially bearish for Canopy Growth stock. If Constellation thought the stock was worth $35 or so in August, and Canopy Growth management was happy to take $35, what’s the point of paying $46 six months later? That’s a 30% or so premium, and yet, not all that much has changed in the meantime.

Again, for long-term believers in pot, that issue might not really matter. But I’m not quite as convinced that legalized, commercially grown marijuana is going to grow as fast — or be as profitable — as those adherents think.

As such, price matters. And with Canopy Growth stock back toward the high-end of the range, it’s tougher to justify the current price. Even investors who are long-term believers might want to consider exiting. It won’t be long before a better, lower price is on offer.

As of this writing, Vince Martin has no positions in any securities mentioned.