Canopy Growth Corp.: How Low Could it Go?

Canopy Growth Corp. (TSX:CGC) is getting clipped. Here’s why investors should be careful.

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Canopy Growth Corp. (TSX:CGC) is down 50% from the high it hit last week, and investors who’d bought the run-up are wondering when the bloodbath will end.

Let’s take a look at the current situation to see if the pullback might pick up steam.

Whoosh!

Did you hear that? Yes, that’s the sound of $1 billion in valuation going up in smoke in the matter of just a few trading sessions.

Anyone who was naïve enough to believe Canopy deserved its $2 billion market capitalization last week has just received a solid reality check, and more pain could be on the way.

Why?

Canopy’s massive run has been on the back of expectations the Canadian government will legalize the sale of recreational marijuana in the coming year.

The federal government set up a task force in the summer to study the issue, and the group is expected to deliver its recommendations by the end of November. The report will serve as a starting point for putting together legislation to be tabled in the spring of 2017.

If all goes according to plan, the market would open in 2018.

Canopy is Canada’s leading medical marijuana producer and is widely expected to dominate a recreational market that some reports suggest could be worth $10 billion per year. Investors have piled into the stock, assuming things are pretty much a done deal, but that might not be the case.

Setting up a countrywide program for the sale of recreational pot is no easy task, and there are going to be speed bumps along the way.

One hint of the potential troubles can be seen in Ottawa, where residents have become so upset with pot shops being set up in their local communities that the police were forced to raid and shut down several illegal but very obvious marijuana dispensaries.

Canada might be a pot-friendly country, but a “not in my back yard” sentiment could run strong in many communities, and that poses risks for Liberal MPs.

The federal government is keenly aware it has to get this right, and strong resistance from Canadian residents could slow down the legalization process or even kill it.

What would this mean for Canopy?

At the time of writing, Canopy is down 20% for the day and trades at $8.35 per share, giving the company a valuation of about $1.1 billion. That’s still lofty for a business that had Q3 2016 revenue of just $8.5 million.

If investors start to think the legalization process could be derailed, this stock could drop like a rock.

How low could it go?

Canopy traded at $4 per share before the massive rally kicked into gear. I wouldn’t be surprised to see the stock retest that level in the coming months.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Walker has no position in any stocks mentioned.

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