The Solar Stock in 2009

Background History on the Broad Stock Market

In order to fully evaluate solar stocks and where the industry will be heading we have to look at the broad stock market first, at least, for some short-term guidance regarding stocks in general. If the market as a whole decides to decline, then all stocks, including solar related stocks will be affected.

As we all know, 2008 was one of the worst years in history for the stock market in general. In fact, the Dow Jones was down 31.1% for the year, which ranks as the 6^th worst year in history.  Take a look at the tables below:

It is interesting to note that when the market goes to extremes (either plus or minus), it tends to correct to the opposite extreme. It appears to build up momentum in one direction and when it finally turns around and reverses itself, it overshoots in the opposite direction.

For example: Four of the worst years ever were 1929 (-17.17%), 1930, 1931 and 1932, which are generally known as the great depression years. However look at the two best years in history, 1928 and 1933. One year (1928) was the top of the bullish extremes of the 1920’s and the other (1933) was the explosive momentum off of the 4 year bear market of the great depression, which continued up through 1935 until this extreme too was corrected in 1937 (–32.82%).

The next serious down period was the recession of 1973-1974 (-27.57%), which was reversed by the strong gains of 1975 (+38.32%).

Most recently we all experienced the “technology bubble” of the late 1990’s and the terrible crash in the technology heavy NASDAQ exchange. The NASDAQ index fell -39.3%, -21.1% and -31.5% in 2000-2001 and 2002 only to rebound UP 50% in 2003.

This strong rebound in 2003 set the stage for the long bull market of 2003 – 2007, which ended in October of 2007 and resulted with the NASDAQ down 40.5% , the Dow down 31.1% and the S&P 500 down 36.1% in 2008.

What can we learn from this brief glance at stock market history?

1. History does seem to repeat itself and as a result we should have some very good years after this current mess has been resolved.
2. The old stock market adage, “Buy them when the blood is running in the streets” appears to hold some validity; it is only a matter of timing when to buy.  Maybe, in retrospect, March of 2009?
3. The reasons why we as investors, never seem to learn from these extremes are in my opinion are very simple and very easy to forget:  fear (stock market bottoms) and greed (stock market tops).

What do these historical trends tell us about the present situation?

They tell me that we have past the fear period — November 2008 until April 2009, and are now in the “worry” period, the period between fear and greed.  Every step of the way since April we have heard the popular financial press tell us all the things we should worry about — foreclosures, the credit crisis, unemployment, the growing deficit and much more.

But surprisingly even though the markets seem to have done amazingly well in such a short period of time in 2009, the market is performing in a very orderly manner and the underlying technical measurements are sound and are still pointing to a higher market despite all of these “worries.” This does not mean that we cannot have normal ups and downs, only that the market is healthier than it would appear at first glance.

Some additional historical data is worth considering at this time:

1.  Since the beginning of this new bull market the market has had 3 corrections of approximately 5%, which is a healthy situation.  A market that goes “straight” up with no corrections is a dangerous situation NOT a healthy situation. 
2. The market has not had a correction of 10% since early March of 2009.  Why is that significant?  It is significant because there has never been a bull market in history that has not had at least one 10% correction before it topped out, according to InvesTech Research.
3. As a result, it is likely that we will have at least one 10% correction and then another move upward before the end of this bull market.
4.  The market has entered its favorable season (November to May), which has historically been a very positive period for stocks.

What Has the Solar Industry Segment Done Year to Date?

The average solar stock year to date has increased 25%, so on the surface it appears that 2009 has been a very good year for solar stocks. However, if you look a bit deeper you will see that while 25% is not bad it is lagging far behind the 36% gain that the NASDAQ has posted.  I am comparing to the NASDAQ because it is the index that most closely resembles the solar sector – mostly smaller companies and technology-related companies.

If you look a little deeper and you take out the two solar stocks with the biggest gains for 2009 – Canadian Solar (CSIQ) + 225% and Trina Solar (TSL) + 378% the average remaining 19 solar stocks actually dropped close to -5% year to date. As a result, while the market in general, and the smaller stocks in particular, have had outstanding years, the average solar stock has done poorly.

In the last 18 months the solar industry has been subjected to a number of negative influences simultaneously:

1. The 2- or 3-year long silicon shortage that drove solar stocks over the past few years has turned into a significant silicon surplus, causing a drop in silicon prices and a resultant drop in panel prices.
2. As a result of #1 solar companies are experiencing extreme margin pressure on their business and therefore, a large number of companies have experienced losses verses prior year gains.
3. The current financial crisis, specifically the credit crunch has resulted in a large number of projects being cancelled or postponed due to lack of financing. This has resulted in an excess build up of inventory and significant pricing pressure on companies to manage their inventory.
4. Solar stocks were the “high flyers” of 2005, 2006 and 2007, far out performing the general market, but in 2008 solar stocks were down 76% on average, over twice the decline of the general market. Individual stocks, industry segments and the market in general always go to extremes and at some point correct these extremes with a swing to the opposite extreme. However, in this case, I do not believe that solar stocks will be able to command the high price earnings ratio (PE’s) that they did prior to this.
5. Finally you have to understand that the solar industry is basically a “start up” industry in the very early stages of its development that is not yet well accepted in the general marketplace and has not fully developed its technology future in any of its market sub-sectors.

What's Next for the Solar Industry?

The next phase of development for the solar industry is the same phase that all industries — autos, semiconductors, computers etc. — had to go through when they were new, i.e. the consolidation and shake-out phase.

The industry without question has a very bright future. However, as in all new industries the strong will survive and the weak will be acquired or go out of business.  New technology will emerge and new leaders will distance themselves from the pack.  This is nothing new and is certainly not be unique in any way to the solar industry. The industry is certainly in for exciting times in terms of growth and dramatic innovation, but it will also be a very dangerous time for investors who are not attentive and very nimble. This is no place for the age old “buy and hold” investment philosophy.

What Can Investors expect?

Investors can expect very erratic movements in solar stocks until the overall market volatility starts to get back to the “normal” range and the industry works out its margin problems etc. One can also expect, and we have already seen, significant industry consolidation and some (unfortunately) company failures.  Keep in mind that this is nothing new in dramatic emerging industries, but remember that with this dramatic growth, will also come greater than average volatility.

With this said is there a way to look at solar stocks (or any stocks for that matter) today and try to “pick” the ones that have the most potential?  Once again, it is impossible to accurately determine which will be the winners and which will be the losers. However I think that there are at least three areas that an investor should look at that I would consider to be critically important especially in the current climate. If a company possesses all three of these characteristics it would, historically, have a much higher probability that it will be a leader in the next phase of the emerging solar boom.

1. CASH.  During times like this cash is king. So an investor will have to make sure to check each potential company’s balance sheet and insure that they have adequate cash reserves to carry them through at least 2010 without need of further financing.
   
   
2. RELATIVE STRENGTH.  In periods like this good stocks and bad stocks both are carried down with the general market. However, the better stocks generally drop last and recover first. These stocks will also most likely be the ones with the most cash (best financial shape) therefore with the best future prospects and ability to ride out tough times.  As a result, an investor should look for the solar stocks with the highest relative strength compared to the general market and to their peer group of solar stocks --  they will be the early leaders in the next market stage and the first to break above their 50-day moving averages (see below).
   1. As a perfect example: the top three performing solar stocks: Trina Solar, Canadian Solar and Yingli Solar ALL initially had and continue to have dramatically higher relative strength as compared to the market in general and to the other solar stocks in their sector. Each of them also broke above their respective 50-day moving average well before the rest of the stocks.
   2. One of the simplest short-term methods I have used over the years to determine trading points for stocks (and the market in general) is the 50-day moving average. To summarize potential buy and sell points:
      i. If a stock is trading OVER its 50-day moving average it is in an uptrend.
      ii. If a stock is trading UNDER its 50-day moving average it is in a downtrend.”

3. PRODUCT DIFFERENTIATION. With a new industry like solar the longer-term leaders are generally the companies with some form of competitive advantage or product differentiation.  Remember these companies may have innovative products, but they must also pass the first two hurdles (cash and relative strength) in order to warrant further consideration as an investment.

Mr. Lynch has worked, for 32 years as a Wall Street security analyst, an independent security analyst and private investor in small emerging technology companies. He has been actively involved in following developments in the renewable energy sector since 1977 and is regarded as an expert in this field. He was the contributing editor for 17 years to the Photovoltaic Insider Report, the leading publication in PV that was directed at industrial subscribers, such as major energy companies, utilities and governments around the world. He is currently a private investor and has from time to time been a financial/technology consultant to a number of companies. He can be reached via e-mail at: SOLARJPL@aol.com. Please visit his website for the promotion of solar energy – www.sunseries.net