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Wait for the Dust to Settle Before Buying Canopy Growth Stock

Canopy Growth is a solid opportunity — at a lower price

Canopy Growth (NYSE:CGC) stock has taken a big hit in the pot stock maelstrom. Shares are down more than 50% since July. But with the stock trading close to its 52-week low, is now an opportunity to enter a position? Like its peers Aurora Cannabis (NYSE:ACB), Hexo (NYSE:HEXO) and Tilray (NASDAQ:TLRY), shares remain richly valued. Despite increasing investor skepticism, people still have faith in the pot stock growth story.

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However, Canopy stock may not be your best play. Jefferies’ Owen Bennett called it “the most expensive name across the cannabis space.” He believes CGC has “material potential,” but is concerned with short-term performance. I agree with his assessment.

While Canopy has the backing of Constellation Brands (NYSE:STZ), the company is quickly burning through Constellation’s $4 billion investment. Much of the upside is already priced into shares.

Recent News at CGC

CGC is facing similar headwinds as its peer Canadian cannabis companies. There is still too much supply in the Canadian market. Everything is riding on December’s rollout of edibles and other high-margin products. The U.S. market remains restricted on a federal level. With gridlock in Washington, legal pot across all 50 states may not come for a few years.

Constellation Brands is playing a bigger role at Canopy Growth. Constellation’s CFO David Klein is now chairman of CGC. While in the past I was bearish on Constellation’s “hidden takeover” of Canopy, I now believe this relationship provides stability during the current pot industry storm.

Another key factor in the short term is next month’s earnings release. For the last quarter, Canopy Growth stock missed revenue estimates by a country mile. Actual revenue for the quarter ending June 30 was $68 million, versus estimates of $84.2 million. Current consensus for the upcoming release is $88 million in revenue. If the company again misses estimates, it will be clear that the CGC growth story is seriously challenged. This could result in additional declines in the Canopy Growth stock price.

Even with the share price depressed, the valuation of CGC stock depends on parabolic growth. Analysts are banking on CGC’s revenue to nearly double between fiscal years 2020 and 2021. But with the way the pot space looks now, is this achievable?

If it is achievable, what’s to say CGC’s stock price doesn’t already reflect that? Let’s take a closer look at valuation, and see whether opportunity exceeds risk with Canopy Growth stock.

Canopy Growth Stock Remains Overvalued

CGC stock continues to trade at a high enterprise value/sales valuation. The stock’s current EV/sales is 28. This is a premium to Aurora’s 21.3 and Hexo’s 21.8. However, Canopy Growth stock remains cheaper than competitors such as Cronos Group (NASDAQ:CRON). CRON trades at an EV/sales of 44.2.

But perhaps using current EV/sales figures is not the best metric. After all, these companies are growing at a rapid clip. Let’s use forward EV/sales to gain a better picture of growth vs. valuation.

Based on fiscal 2021 estimates for Canopy Growth ($858.2 million in revenue), CGC stock’s forward EV/sales is 7.2. Using similar metrics (FY21 sales), Aurora’s forward EV/sales is 5.7. Tilray has estimated sales of $350.1 million for the year ending December 2020. Based on this, TLRY’s forward EV/sales is 6.3.

In other words, even on a forward EV/sales basis, CGC stock trades at a premium. One could make the argument that Canopy is better positioned to meet its growth targets. But based on prior results, it is in the same boat as its competitors.

All bets are off whether the Canadian pot market will continue to see parabolic growth. Perhaps Cannabis 2.0 will be a gold mine for the cannabis world. But until it becomes clear the U.S. market will fully legalize marijuana, I am skeptical that these targets will be achieved.

Bottom Line: Canopy Stock Could Fall Further

Based on valuation, there’s plenty of room for CGC stock to fall further. Relative to growth prospects, peers such as Aurora and Tilray could be cheaper plays. And that’s if Canopy can even meet its ambitious sales targets. The recent troubles at Hexo could be the tip of the iceberg.

I do not believe the pot stock party is over. But it’s definitely not the right time to crash it. Investors are looking for the exits. While in the long term the pot industry could grow into a major industry, marijuana stocks remain overvalued. Canopy Growth stock is no exception.

Constellation’s backing minimizes upside, but could help Canopy weather the storm. The company can seize the opportunity and become a dominant player while weaker pot companies stumble.

So what’s the call on CGC? Sit and wait. At a lower price, Canopy Growth stock could be a screaming buy.

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

Article printed from InvestorPlace Media,

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