Canopy Growth Corp. (TSX:CGC) is a fantastic story of a company emerging as a market leader in a new, potentially massive market. The company has announced incredible results from its customer base as well as top- and bottom-line results with positive earnings and impressive revenue growth.
The company, however, is a speculative gamble for the long-term investor for a number of reasons. I will dive into a few key problems of investors who look for sustained long-term profitability.
The stock is fundamentally overvalued
Looking at a few key metrics, even when a 300% quarterly revenue growth rate is factored in for the next four to eight quarters, the numbers don’t make any sense. The forward 2018 price to earnings (P/E) ratio, which factors in expected revenue and earnings-growth rate based on historical trends, is 448. This is absurdly high, even for a “poster child” growth company.
There are a few other examples of over-marketed “growth gems,” such as Amazon.com (NASDAQ:AMZN) and many other internet-based businesses, which maintain high P/E ratios for long periods, but they are rare. Amazon’s current P/E ratio is 170, and the company has maintained a forward P/E higher than 100 for many years. A forward P/E of 448 gets to be a little too much, even for the most optimistic out there.
Marijuana is (or will be) a commodity
Marijuana, when legalized, will be a commodity. Commodities trade at commodity prices; margins are razor thin. The oil and gas industry, for example, produced record profits when prices were high; however, commodity prices go through cycles, and we are currently seeing the effect of over-investment and leveraged over-expansion in an industry that made nothing but money for many years.
Volatility based on market prices for marijuana needs to be properly factored into the stock price. Regulation and taxation related to the pricing of marijuana will likely come into effect; the Canadian government is very likely to set taxation levels and price floors for marijuana similar to those of tobacco.
Investors might say, “Aren’t price floors a good thing for a marijuana manufacturer?” While the potential for these price floors will, in theory, allow for higher retail prices, much of the difference in the price of the manufactured product and the point of sale product will be eaten up by taxes. Competition for market share will theoretically eat up another chunk of profit. Regulatory burden, quality assurance, and various forms of government oversight and bureaucracy are all long-term risks posed to any new player in this infancy-stage industry.
The hype surrounding the burgeoning marijuana industry mixed with the unknown top- and bottom-line profitability of the marijuana sector make this stock prone to mispricing.
In my opinion, that is exactly what is happening here.
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Fool contributor Chris MacDonald has no position in any stocks mentioned. David Gardner owns shares of Amazon.com. The Motley Fool owns shares of Amazon.com.