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Canopy Growth Corp.: What Went up in Smoke in 2016?

Canopy Growth Corp. (TSX:CGC) was among the most exciting stocks of last year. While some investors who keep their ears low to the ground, looking for new investment ideas, bought early and did well, others got caught up in the hype and lost a considerable amount of money in only the past two months. For certain investors, the good news is, this roadrunner has far from finished the race.

Trading at a price between $9 and $9.50, there is no question about the company’s future profitability. But if you remove the speculation from the equation, this is not an obvious long-term investment that deserves the current price tag of over $9.

Throughout 2016 and even back in 2015, investors searching for the new, hot growth industry were starved. There was really nothing emerging with the potential to scale like Canopy Growth Corp. in quite some time. The irrational buying and selling which came along in the latter part of 2016 was completely understandable.

Going into 2017, the Canadian government was clear: marijuana will be consumed legally.

With the massive potential of the legalization of this product, we are led to reflect on the situation and how it will impact companies like Canopy Growth Corp. As we know, the company grows the product and then sells it to retailers, who in turn sell it to consumers. With the potential in 2017 and beyond, the industry setup will be very clear. Similar how coffee is grown and sold wholesale to coffee shops, which in turn roast it their own way and sell it to individual consumers, marijuana will be no different.

Once the marijuana is grown and sold to marijuana stores, the store owners will have the opportunity to “roast the coffee” and differentiate themselves through either baked goods or other means. Whether buying from Canopy Growth Corp. or another grower, the product differentiation will happen at the retailer level and not at the producer level. Over the long term, there will be no excess profits which will ever be earned by a marijuana grower.

As we move forward with this stock in 2017, the only clear catalyst possible is a takeover from another larger player, such as a tobacco company. Alternatively, just as profits went up in smoke in the last month of 2016, the 2017 result will be no different.

With negative cash flow and a recent quarterly profit resulting only from an increase in the value of the inventory, responsible investors need to be very cautious while deploying money into this industry. What may be higher than normal profits for a short period of time will quickly come back in line with the proper economics of the industry. History in the state of Colorado has already proven it.

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 Ryan Goldsman has no position in any stocks mentioned.

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