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Canopy Growth Corp.: Patience Is a Virtue

With Canopy Growth Corp.’s (TSX:WEED) shares having fallen 50% since February, investors are wondering if it is time to buy. I mean, they have fallen 50%, so they must be good value, right?

Well, in short, the answer is no. Because the stock has fallen from such highs, we can arguably say it never should have been that high in the first place.

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 still see when I look at Canopy’s stock.

Clearly, this industry has a lot of growth potential with estimates that the medical marijuana market in Canada will be over $1 billion by 2020.

And clearly, Canopy has an enviable position in this industry. But being an industry that is essentially at its infancy, we must bear in mind that market conditions and companies involved in it are all subject to heightened risk.

Here are the red flags I’m looking at that make me wary about investing in this exciting company at this time.

The company reported a 260% increase in registered patients and a 180% increase in year-over-year revenue, yet the stock is down over 50% since February, in part because this increase was lower than analysts and the market was expecting. This is a bad sign, and an indication that expectations are getting too high.

The stock is trading at over 40 times sales (versus over 60 times revenue back in February) and has no real earnings yet. It is one thing to produce revenue, and another thing entirely to produce a profitable business. Yet, at over 40 times revenue, the stock is still trading at levels that have a lot of very optimistic assumptions baked into it.

So, in summary, I’m in total agreement with the excitement surrounding the medical marijuana industry. 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 longer-term view of things, and when we see these situations, to be confidant enough to wait it out and focus on capital preservation as well as potential returns.

Either the stock price will decline to make valuations more reasonable, or the company will show revenue and earnings increases that prove the assumptions that are baked into the stock. Let’s make sure we buy low and sell high, and not the opposite — patience.

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Fool contributor Karen Thomas has no position in any stocks mentioned.

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