Marijuana stocks such as Canopy Growth Corp. (TSX:WEED) are becoming reminiscent of the early 2000 internet or dot-com bubble.
As the internet expanded, the excitement grew, and optimism flared. More and more analysts were projecting really bold and optimistic growth numbers, and stocks skyrocketed accordingly. It seemed like new internet companies surfaced every other day and their stocks all did very well, trading at double-digit multiples of sales. Until they didn’t, and in 2000 everything came crashing down. The NASDAQ fell from a high of over $5,000 in March 2000 to lows of just over $1,200 in July 2002. That’s a two-year decline of 76%.
So, what does this have to do with Canopy Growth? The very nature of a bubble is that stocks are trading on hype, excitement, and hope, and not as much on fundamentals. And when this happens, the risk/reward profile of a stock becomes skewed. That is, the risk inherent in the investment far outweighs the potential reward because the stock is reflecting unrealistic, wildly optimistic scenarios. And this is what I see when I look at Canopy’s stock.
Clearly, this industry has a lot of growth potential; estimates put the medical marijuana market in Canada at over $1 billion by 2020.
But here are the red flags I’m looking at that make me wary about investing in this exciting company at this time.
First, the company reported a 260% increase in registered patients and a 180% increase in year-over-year revenue, yet the stock is down over 8% at the time of writing because this increase was lower than analysts and the market expected. This is a bad sign and an indication that expectations are getting too high.
Second, the stock is trading at over 60 times sales and has no real earnings yet. It is one thing to produce revenue, and another thing entirely to produce a profitable business. Yet the stock is trading at levels that have a lot of very optimistic assumptions baked into it.
In summary, I’m just not a fan of buying into hype, and right now, that is what this stock feels like. As investors, I think it is a good idea to take a long-term view of things and, when we see these situations, to be confidant enough to wait it out and see how it goes. Either the stock price will decline to make valuations more reasonable, or the company will show revenue and earnings increases that prove the assumptions are baked into the stock.
Let’s make sure we buy low and sell high, and not the opposite.
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Fool contributor Karen Thomas has no position in any stocks mentioned.