Canopy Growth (NYSE:CGC) has surged higher on a deal that will position the firm to buy U.S.-based Acreage Holdings (OTCMKTS:ACRGF). The agreement, contingent on the U.S. legalizing marijuana at the federal level, would position Canopy as the leading cannabis company in the U.S. Unfortunately for investors, Canopy Growth is not CGC stock.
With CGC trading at bubble-like multiples and the challenges facing marijuana stocks and the market in general, I would not buy Canopy Growth stock on the proposed Acreage deal.
The Acreage Deal Is a Visionary Move for Canopy Growth
From a business standpoint, I love this deal with Acreage Holdings. Now that Canada has fully legalized weed, the focus has shifted to the U.S., a market with nearly nine times the population. Yes, marijuana remains illegal on the federal level. However, the deal only occurs if the U.S. legalizes cannabis nationwide.
Moreover, it looks more like pot’s legal status in the U.S. has become only a question of time. The Jeff Sessions tenure as Attorney General was likely the last hurrah of the pot prohibitionists. Former Republican House Speaker John Boehner once opposed weed. Now he has become a leading advocate of legalization. Even deep-red states have moved to loosen restrictions.
Once weed becomes legal, the deal probably leaves Canopy in a better position to benefit than any of its peers. As a result, CGC stock has risen by nearly 19% in ten days.
In one sense, I find this surge understandable. Due to investments by Constellation Brands (NYSE:STZ) and now, the Acreage deal, I see CGC as the stock to own within this sector. However, a bigger question hinges on whether investors should own stocks in this sector at all.
CGC Stock Faces Unappreciated Dangers
Marijuana stocks have returned to the high multiples seen right before Canada officially legalized. While I see CGC stock and many of its peers as long-term winners, traders need to exercise caution. CGC trades at more than 96 times sales and over 357 times forward earnings. For now, such multiples have become the norm in this industry. Still, investors need to remain wary of these valuations for two reasons.
First, the current bull market has reached its 11th year. This does not necessarily mean that stocks will stop rising soon. However, it increases the danger of such a downturn. Investors tend not to tolerate high valuations under such conditions.
Moreover, we should not forget that legalization in Canada set off a “sell the news” type of reaction across the sector. As a result, CGC stock fell by over 57% between October 16th and December 24th. Thanks to pre-legalization anticipation switching to the U.S., Canopy Growth stock recovered most of that lost value.
Still, after pot achieves legal status in the U.S., CGC stock will more than likely compare to Altria (NYSE:MO) or that of its largest investor, Constellation Brands. Both MO and STZ have long supported relatively low P/E ratios and high dividends. Such stocks usually benefit from healthy revenues, but they generate little investor excitement.
Analysts predict 80.4% earnings growth for CGC next year. Despite that rate of increase, it will take more than another 57% drop to make Canopy look like an Altria. I would recommend CGC stock if it became such an equity. However, at current levels, I see more danger than upside.
The Bottom Line on CGC Stock
Both valuation and the likely late-stage status of the current bull market make CGC stock one to avoid despite the Acreage Holdings deal. Assuming pot achieves full legal status in the U.S., the Acreage deal will probably position Canopy Growth ahead of its U.S. and Canadian peers.
However, the problem lies with CGC stock itself — and all marijuana stocks. With multiples already in the stratosphere, it will need ever-higher levels of euphoria to surge higher. In the 11th year of an overall bull market, that order only becomes taller. Consequently, the Acreage-driven surge looks more like a selling opportunity than a buy signal.
If and when the U.S. legalizes, Canopy Growth stock will likely become one that supports a low P/E and pays a generous dividend. Until CGC looks ready to become that type of stock, traders face more potential risk than reward.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.