The worldwide cannabis industry has seen explosive growth in recent months, and everywhere you go, investors are talking about marijuana stocks and their huge gains. Attention among marijuana investors is now squarely on Canada, where the legalization of recreational cannabis is set to happen later this month. That's drawn huge interest in Canopy Growth (CGC +0.93%), which has emerged as a key grower of cannabis and a potential market leader when Canada's recreational market opens up.
There's no disputing that Canopy Growth has a huge opportunity. But few dispute the fact that Canopy also faces plenty of risks. Indeed, the company itself has identified what it thinks are five of its biggest risk factors, and anyone who wants to buy shares of the Canadian cannabis company needs to understand them and have comfort that Canopy will be able to overcome the obstacles in its path.
Image source: Canopy Growth.
Don't ignore Canopy's risks
Whenever you're looking at making a new investment, getting up to speed on a company's regulatory filings is essential. Even though Canopy Growth is a Canadian company, its listing on the New York Stock Exchange forces it to comply with U.S. Securities and Exchange Commission disclosure rules. The required disclosures include a list of key risk factors that Canopy has identified as being meaningful for its shareholders.
Canopy's latest statement of its biggest risks comes from its 2018 annual report. The Canadian company filed that report back in June, but the potential problems it identified remain important as a road map of possible pitfalls that Canopy will have to navigate in order to succeed.
1. Regulation of marijuana is evolving, making it hard for Canopy to comply.
Cannabis is highly regulated in most jurisdictions in which Canopy does or is seeking to do business, and the company is well aware that laws and regulations can change quickly in unforeseen ways. Especially in the medical cannabis realm, it's essential for Canopy and other marijuana companies to follow what national health authorities like the U.S. Food and Drug Administration and Health Canada require. Otherwise, failing to get approvals could put Canopy at a huge competitive disadvantage from which it might never recover.
2. Canopy could face product liability claims.
Marijuana companies have learned from the experience of the tobacco industry, and they're eager to avoid the potential product liability litigation that plagued major cigarette manufacturers for decades. Nevertheless, Canopy acknowledges that it will almost certainly face lawsuits if "the products we produced caused injury or illness, including inadequate instructions for use or include inadequate warnings concerning possible side effects or interactions with other substances." Health advocates who oppose tobacco use have effectively mounted anti-smoking campaigns that have led to substantial reductions in tobacco sales volume over the years, and if problems arise with cannabis, Canopy and others could face similar pushback.
3. Acquisitions and collaborations could be unsuccessful.
Canopy has made many acquisitions in order to bulk up its production capacity, and its partnership with Constellation Brands (STZ 0.06%) has made it stand out from its peers. But Canopy knows that there's no guarantee that it can effectively integrate acquired companies into its existing operations, and strategic alliances might not work out the way both parties had hoped. For instance, with some speculating that Constellation will eventually acquire Canopy outright, a failure to do so could be disappointing to shareholders of the Canadian cannabis company.
4. Future stock offerings could dilute investors.
Canopy correctly notes that it might need access to more capital in the future, and offerings of its stock could be an essential part of any capital-raising efforts. Often, secondary stock offerings result in an immediate drop in the share price, as current shareholders anticipate having their interests in the company diluted by the rise in outstanding share count. So far, Canopy has been able to get debt financing to avoid dilution, but changing industry conditions could make such financing too costly to use as a practical funding solution.
5. Canopy's stock price has been volatile and could remain so.
The most obvious risk that Canopy shares with every other marijuana stock is that the craze among investors has led to huge volatility. Share prices move on the smallest piece of news -- and sometimes with no apparent justification at all. Sometimes, news can move Canopy stock even when that news is only about another company and doesn't really apply to Canopy. If you're going to invest in Canopy or any other marijuana stock, you have to have a hard stomach to endure the inevitable ups and downs.
Learn more about Canopy
Canopy Growth has made a compelling case to be a leader in the budding cannabis industry, but it's far from a sure thing. Before you invest in Canopy or any other marijuana stock, make sure you know as much as you can about its business and the challenges that it faces.
