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Canopy Growth Corp.: Calm Before the Storm?

The volatility for Canopy Growth Corp. (TSX:CGC) eased off Friday as the stock managed to remain flat at 0%. This looks to be the calm before the storm. I believe there could be a major correction in store for Canopy once the buyers start getting exhausted and the short-sellers start piling into the stock.

There’s no question that any small bit of news will send the stock flying or crashing by double digits, and if there’s no news, I believe the stock will fall by default, because right now the stock is just too expensive, and the high price is not sustainable without a consistent flow of positive news to reassure investors.

If you’re making an investment in Canopy at these levels, then you’re making a bet that there will be good news coming in on a regular basis. If this doesn’t happen, then you could have huge losses on your investment due to the huge premium that you’re paying for the company right now. You’re not paying for fundamentals; you’re paying for future hopes, and these hopes will be realized in the form of good news.

There’s no question that Canopy is a stock that’s ruled by traders, and even if you’re a long-term investor, you’re playing the short-term game by jumping into this stock. You’d better be comfortable with ridiculous amounts of volatility because I don’t think the eased volatility will stay for very long.

Where will the storm take Canopy?

It could go either way, but it looks like Canopy is ramping up with its acquisitions, which will boost its production capacity and help it expand on an international scale. In my previous piece, I stated that the acquisition of the German pot producer and distributor MedCann could lead to a whole bunch of acquisitions.

This indeed happened; Canopy made an agreement to acquire Mettrum Health Corp. for $430 million, which comes at a huge premium. Mettrum Health Corp. has six production facilities, which will help position Canopy as an industry leader.

Going forward, we can expect Canopy to continue its M&A spree in order to drive growth and profitability in a new and emerging market.

There’s one problem with this. Canopy is paying a hefty premium on these acquisitions. Despite Canopy’s fantastic growth potential, I believe the company should look for value when making acquisitions, because, as we’ve seen with Valeant Pharmaceuticals Intl Inc., going on an acquisition spree for the sake of increasing the stock in the short term is never a good idea.

Canopy is in good financial health and doesn’t have the massive amount of debt that Valeant had during its acquisition spree. The acquisitions are also a lot smaller than the ones Valeant made, so I don’t believe the stock is headed for the same fate as Valeant, but Canopy is paying large premiums for companies.

If all things go according to plan, then these premiums will mean nothing in the long run, but if government regulation starts working against Canopy, we could see some downside.

Canopy is a speculative gamble right now, and, although it’s not a Valeant, there could be huge downside because of the bubble that looks to be forming in the stock. I would avoid it and wait for the storm to bring the stock back down to more reasonable levels.

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Fool contributor Joey Frenette has no position in any stocks mentioned. Tom Gardner owns shares of Valeant Pharmaceuticals. The Motley Fool owns shares of Valeant Pharmaceuticals.

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