Canopy Growth Stock Could Drop to $30

Canopy Growth Corp (NYSE:CGC) just reported their quarterly earnings last week, and they weren’t good. Looking over the report, here are three things that CGC stock investors should be concerned about:

CGC Stock: Canopy Growth Stock Could Drop to $30

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Important CGC Stock Numbers

First, the operating income loss just was significantly worse than estimates, coming in around CA$175 million. But it is even worse than it sounds. Part of what CGC management says were in the earnings, were “fair value” adjustments. This amount was about CA$75 million.

What is a “fair value adjustment?” Well, basically management sits around a table and says “you know all that weed that we have stored in inventory? It’s now worth CA$75 million more than we said it was before.” So without management saying that their inventory was worth more than they had previously valued it, the loss for the quarter would have been closer to CA$250 million.

Fair value can be very subjective.  When most companies make fair value adjustments to the value of their inventory, they typically reduce the value.

The second thing that would concern me is that Goodwill is very high. What is “goodwill?” It is basically managements opinion as well.

For example, say a company buys a another company that is worth $10 million, and they pay $15 million for it. This extra $5 million premium will now be considered goodwill. It supposedly includes intangible things such as reputation and clients.

So basically, if company A buys company B and overpays for it, company A’s valuation will increase by the amount of the overspend. A company’s management decides if it will acquire another company and what they will pay for it. It is their opinion. Like fair value, goodwill can be very subjective.  Canopy’s overall goodwill is CA$1.8 billion. CGC’s opinion on goodwill increases the overall valuation of the company by almost 20%.

The third and probably most important thing that would concern me is the chart.  We could be setting up for a big drop.

The chart doesn’t look good. The $40 level is being tested. This level was support in April and again in early June. If it breaks, and I think it will, we could see a significant move lower. That is because there is no other clear support until we get down to around the $30 level.

Early in the year, CGC gapped up from $30 to $40. Gaps tend to refill. This is because the stock only spends a short period of time trading at the levels that it gapped through. This means a meaningful amount of vested interest does not form.

For example, support forms because the people who sold a stock at a certain level get upset when the stock goes higher. They tell themselves that if it comes back to the level that they sold it at, they will buy it back.

The short sellers are looking at a loss and they tell themselves that if it gets back to the level that they went short, they will buy it back to break even. Those who bought it only to see it go higher tell themselves that if it comes back to the level they bought it at, they will buy more. Now we have three groups of buyers. This is how support forms.

When a stock gaps up like CGC did in January, it doesn’t spend much time trading at the levels that it gapped through. Because of this, there isn’t time for meaningful support to form. This means that when the stock trades back down into these levels is can gap right back through them because there isn’t much support.  I do not see any clear support levels until we get down to the $30 level.

As of this writing, Mark Putrino did not hold a position in any of the aforementioned securities.

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