Growth investors are searching for leaders in emerging industries.
These businesses are often viewed as being in the early stages of a potential long-term rally and could deliver big returns when investors identify the opportunity at the right time.
Canopy Growth Corp. (TSX:WEED) might be the most popular growth name in Canada right now, and investors who’ve missed the rally over the past year are wondering if more gains could be on the way.
Let’s take a look at the current situation to see if Canada’s largest cannabis company deserves to be in your portfolio.
Canopy is the current leader in Canada’s medical marijuana sector and is laying the groundwork to capitalize on opportunities in several other countries.
Management had the foresight to make a series of strategic acquisitions in the past two years, including the 2017 purchase of Mettrum Health, which added key national brands and important production capacity.
Canopy knows the key to success lies in the ability to meet growing demand, and it has taken important steps to boost its production footprint. For example, the company purchased the large property that houses its headquarters, giving Canopy an extensive opportunity to expand production at the site.
In addition, Canopy has partnered with the Goldman Group to fast-track its production growth. Goldman is buying or building facilities and outfitting them to meet Canopy’s production requirements and then leasing them to Canopy.
Canadian recreational market
The medical marijuana sector continues to grow, but the big opportunity lies in the expected recreational market.
Canada plans to launch a legal pot market in the summer of 2018, and the provinces are scrambling to get their ducks lined up to hit the federal government’s target.
Estimates for the market size in Canada start at about $5 billion, so it is easy to see why investors are so excited. Canopy has already announced provincial supply agreements, and it is possible Canopy could capture a significant chunk of the recreational market when it opens.
Canopy is also eyeing international opportunities. The company owns a pharmaceutical distributor in Germany and has entered joint-venture or partnership agreements in several countries, including Australia, Spain, Brazil and Chile.
Canopy’s stock received a nice boost in late 2017 when Corona-owner Constellation Brands announced a 9.9% stake in the company. Constellation hopes to sell cannabis-infused beverages in markets where recreational consumption is legal.
Canopy’s stock has risen from a low of about $7 last summer to a high above $40 per share in the past week. The stock has not gone straight up, however, and more volatility should be expected.
Daily moves of more than 10% are becoming quite common.
At the time of writing, Canopy trades for $36.50 per share. That puts it at a market valuation of about $7 billion.
The price is tough to justify based on the company’s financial performance. In the most recent quarterly report, Canopy generated less than $18 million in revenue and still hadn’t turned a profit.
It is common for growth stocks to trade at high valuations before they make any money, but investors might be getting ahead of themselves.
Canopy is making all the right moves to strengthen its leadership position, but everything has to go according to plan in the roll-out of the recreational marijuana market to justify such a lofty valuation, and that is far from guaranteed.
As a result, the downside risk could be significant.
Should you buy this stock?
Canopy might grow into its valuation, and I wouldn’t be surprised if the stock moves higher, but buying today looks risky, and investors should be prepared for ongoing volatility.
If you’d bought the stock last year, it might be a good idea to take some profits. For those considering a new position, I would wait for a significant pullback or look for other opportunities.
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Fool contributor Andrew Walker has no position in any stock mentioned.