Naturally, the anticipation of cannabis legalization boosted Canadian companies like Canopy Growth Corp (NYSE:CGC), with CGC stock gaining 22% in the past 30 days.
Last week, many “botanical” advocates argued that Canada took a decisive step into the 21st century. Through legalizing recreational marijuana, our northern friends became the first G7 nation to end legal stigmatization of the plant.
However, even the excitement of Canada greenlighting “green initiatives” wasn’t enough to spare blushes for the sector. Those speculating on CGC stock learned that lesson the hard way at the end of last week.
After enjoying a robust start to the week beginning June 18, the marijuana grower shed nearly 9% of market value.
Not only that, the volume level was quite intensive at nearly 7.6 million shares. Obviously, a great many stakeholders secured profits while they could.
I don’t think anyone can blame them. While CGC stock enjoyed a brilliant performance in 2017, this year has produced a mixed bag. Optimists point to the company’s recent rally as the true indicator of its potential.
Since the May 1 opener, CGC skyrocketed to nearly 42%. But on a year-to-date basis, shareholders nervously spent most of their time underwater.
Our own Ian Bezek notes far more fundamental reasons why CGC stock underwhelmed, and why this might continue. Bezek argued that Canopy’s 9.9% owner Constellation Brands (NYSE:STZ) is practically the only real winner with CGC.
Constellation entered at a great price, and tripled their investment in under a year.
That said, buying Canopy is buying an overly bullish story that might not pan out. Bezek brings up the astronomical 100-times price-to-sales ratio. As he states, “A 100x price/sales ratio is nearly unheard of in the history of publicly traded stocks.”
Is CGC Stock Too Risky?
I certainly respect Bezek’s arguments as he largely points out facts. Yes, Constellation Brands did benefit handsomely from its Canopy deal, but you are not Constellation Brands.
Conflating successes could lead to disaster. And he’s also right that the P/S ratio is alarming.
Astute investors often use this metric to determine growth potential and value for young companies that might not have earnings. Bezek states that “The company sold only $55 million in product last year, but the market values that at more than $5.7 billion.”
So we should pass up CGC stock, right? If you’re a conservative investors, then yes, you definitely should avoid Canopy. However, if you don’t mind taking some risks, CGC isn’t nearly as speculative as it appears on paper.
First, I argue that the P/S ratio is somewhat irrelevant with marijuana companies. Recreational marijuana just became legal in Canada. We don’t have a precedent for this absolute paradigm-shift.
Yesterday, you could have been thrown in jail for smoking a joint. Today, you can light up freely.
In other words, excessive optimism is baked into CGC stock because the sky’s the limit.
Second, Canopy could be undervalued. No, that’s not a typo, and no, you don’t have to call an ambulance: my mental capacity is just fine.
In my last write-up for the marijuana industry, I cited a Dalhousie University-sponsored report. In their analysis, the research team discovered that nearly 46% of Canadians would buy “marijuana-infused food products” if legally available.
These aren’t just dedicated potheads, unless you believe that nearly half of Canada’s population is baked. Rather, this is a brand new market that appeared like manna from heaven.
I’m not sure if CGC stock is truly undervalued or not, but this possibility is a very real one.
Read Between the Lines
I agree wholeheartedly with Bezek that Constellation Brands is the runaway winner with Canopy Growth. I also don’t necessarily disagree that STZ stock is the better way to play Canopy. But we should also consider why Constellation invested in CGC.
As an alcoholic-beverage maker, Constellation is a known commodity. Don’t get me wrong: I think it’s a great company. I also featured STZ as one of the top “vice stocks” you should consider adding to your portfolio.
But the low-hanging fruit in the alcohol industry has been plucked long ago.
With recreational marijuana, though, everything is low-hanging fruit. That’s why major growers like Aurora Cannabis Inc (OTCMKTS:ACBFF) and Aphria Inc (OTCMKTS:APHQF) aggressively compete in this sector. This trend will only heighten in the years ahead.
And in this crazy green world, Canopy levers a huge advantage: its partnership with Constellation. While marijuana may be the people’s plant, let’s not forget that big business will ultimately have its say. This will leave out the little guys, and consolidate growth among a few.
That’s why Constellation has a heavy stake in Canopy. As great as they are, the alcohol industry is as old as time. Marijuana is just stretching its legs. With CGC stock, Constellation plants a big footstep in tomorrow’s groundbreaking sector.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.