Solar

Solar Stocks: Factoring in the Boom & Bust Cycle When Investing

Solar stocks have a bright future, a very bright future. But investors have to understand a number of things about the current stock market — and solar stocks in particular — in order to fully take advantage of this long-term trend.

Markets go up and markets go down and these moves usually occur when no one is expecting it. At the present time solar stocks, the energy industry and the market in general have been very “hot”. The Dow Jones is breaking records everyday and the press is full of “bullish” solar articles.

If we take the time, look a little deeper and put aside the general media. I think we will see a very different picture and one that would suggest investor caution at this time.

The General Market
Last month the Dow Jones Industrial Index recorded advances in 21 of 24 trading days, the best performance run since 1955. This stellar news was all over the financial press, accompanied by optimistic scenarios of equal or better future performance—all was well in Wall Street Land. If one looked a bit closer, however, they would see that the “real” picture was not quite as rosy.

The general market breadth was positive (advancing stocks were greater than declining stocks) in only 12 of the 24 days for the NASDAQ index (most technology and smaller stocks). This tells me that while the Dow Jones (only 30 stocks) was moving up strongly, the vast majority of stocks were neutral to weak. This is a well know term called “divergence” and it tends to occur toward the end of a very bullish period.

In addition, over the past couple of months the general markets have been advancing, yet divergence as measured by 12 month highs and lows as been declining.

Consequently, I would view the current overall market as a “higher” risk market and one in which no new buying should be done.

The Solar Stock Sector
Solar stocks have also been doing very well since the fourth quarter of 2006. But just like the general market, we need to look a little deeper, past the media hype, and see what is actually happening in the solar sector of the market. One of the measures (tools) that I utilize when looking at individual stocks is their 50 day moving average and whether the current price is above (bullish) the 50 day average or below (bearish) the average.

It is not the only way to look at stocks and may not be the “best”, but it always seems to give me an idea of which way a stock is heading in the short to medium term.

Back in September and October of 2006 all of the publicly traded solar stocks I follow regularly (15 in the U.S. and 12 in Germany) were just advancing through their 50 day moving averages. Currently, 12 of 15 (80%) of U.S. solar stocks are below their 50 day average and 9 of 12 (75%) of German stocks are below their 50 day average.

This tells me that, more than likely, the solar sector is weakening and is potentially headed for a corrective phase.

Current Risk-Reward Situation—Higher Risk
There have been a number of studies done on what makes a stock go up or down in the short term. One study that I have found to be fairly accurate is summarized below:

• 30% to 40% of a stocks price action is the result of the general stock market;
• 40% to 50% of a stocks price action is the result of how the sector the stock is in is doing, in this case the solar sector; and
• 20% a result of developments in the stock (company) itself.

As a result, if we look at the current situation, just a little below the surface, it is a combination of a higher risk overall stock market and a solar stock sector that is overbought. Given these odds this would certainly seem to not be a time to be buying solar stocks.

Wall Street Wisdom & General Lessons
Assuming the above analysis is reasonably correct, what wisdom and benefits can be gained from this current situation?

1. Markets and stocks ALWAYS get ahead of themselves (in the short term) and go up too far, too fast. I think we are in this situation now with solar stocks.

2. When an investor is researching potential investments they must understand that a company needs to be looked at in two ways: as a company with a business; and as a stock, separate from the business of the company. What I mean by that, is that you can have a good company and a bad stock-and you cannot “fall in love” with either.

A perfect example of this is one of the greatest and most respected companies in the world-General Electric. In November of 1987 (after the stock market crash of 1987) the stock was $3.25 per share. In August of 2000 the stock was as high as $60.00 per share. Good company and a good stock.

However, since August of 2000 the stock has been in a general decline and reached a low of approximately $22.00 in February of 2003 and is currently trading at approximately $37.00, no where near its high of almost 7 years ago.

Has General Electric become an unsuccessful company that is going out of business and has no future? I seriously doubt it, but it is an almost perfect example of a good company (possibly “great” company), with a bad stock.

3. The solar industry has a very bright future, for decades to come. However, you have to keep in mind that we are only at the very beginning of the industries growth. As a result, in addition to enormous opportunities that lie ahead, we will also most likely see above average volatility and more technical failures than successes. This is the way all new industries start up, grow and finally emerge-and investors have to be aware of this level of risk (and opportunity) and act appropriately.

4. As a result of this increased level of volatility I would advise that investors make sure that they match their risk profile with their investment practices. Emerging industries, such as solar, should be approached with a good degree of caution, except for investors with a high speculative tolerance.

5. Conservative investors can take a look at a number of Exchange Traded Funds (ETF’s) which are baskets of stocks in a given market segment and allow a more diversified approach to that sector. Some examples in the solar area can be found at PowerShares under products, sectors, cleantech.

Patience is a Virtue
Any correction in solar stocks or the market in general can also be turned around and provide an advantage for the patient investor. When a sector or market corrects it generally takes all stocks (good and bad) down with it. However, once the correction has run its course the stronger stocks will ALWAYS come back to life faster. This is an excellent way for an investor to pick out the stronger companies in the sector and get involved before they have fully recovered.

Aspiring investors need to acquire and nurture patience. Historical data clearly shows that more money is made MISSING the downside than catching the upside. Investors who were fully invested in early 2000 have STILL not recovered from their losses over 7 years ago. As I read my e-mails from readers, I get the feeling that people really want to buy solar stocks and ride them into a bright future. Many times I get the sense that they are afraid, that if they delay, they will miss the chance to profit from the solar industries bright future. This is NOT true. There will be plenty of time and many advances and declines in the future. Be patient, look for the strongest stocks and try not to get swept up in the crowd, because the crowd is always wrong.

J. Peter Lynch has worked for 30 years as a Wall Street analyst, an independent equity analyst and private investor, and a merchant banker 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 area. He is currently a financial and technology consultant to a number of companies. He can be reached via e-mail at [email protected]