The solar power industry has spent the last decade or so under a cloud, if you’ll forgive the pun. As multiples have done what they usually do, that is return to the mean, solar power stocks have been left behind.
The S&P 500, taken as a whole, is trading near the historical average P/E, at close to 16. In the solar industry, meanwhile, two of the best known companies, First Solar (FSLR) and Canadian Solar (CSIQ) are trading at 6.96 and 12.63 times forward earnings.
There are several reasons for this anomaly. As the industry transitions from heavy government subsidies, many of the companies have become quite heavily leveraged. CSIQ, for example, has a debt to equity ratio of over 200. Earnings, while they have spun to positive in both of the above examples, are inconsistent. Above all, there is an uncertainty about future supply in the industry as some countries, most notably China, encourage production for strategic, rather than economic reasons.
I understand all of this, but, basically, cheap is cheap. The fact that a stock or industry is undervalued doesn’t mean that it is sure to go up, but it does mean that downside is to some extent limited, making for a decent trade. Of course, none of that is true in a declining industry, but solar power is hardly that.
We all know the case for solar and alternative energy in general. Fossil fuels are dirty and finite. As the world population continues to expand and the demand for energy increases in our increasingly tech dominated lives we will someday be forced to embrace renewable energy in some form or other. The problem is that people have been saying that for decades and each new technological advance in conventional fuels, deep water drilling and hydraulic fracturing for example, seem to delay that day even further. Delayed or not, though, it will come.
That certainty makes some long term holdings in the solar power industry and other renewable a desirable thing and buying in while they are still cheap a sensible thing to do. Even though this is a long term strategy, though, good trading discipline is still required. Solar power is a volatile sector, pushed around by energy prices in general and the oversupply concerns mentioned above, so protecting yourself against a downturn is prudent. My interest in both FSLR and CSIQ comes, in part, because both offer logical stop loss levels that can be used to protect against hefty losses.
After jumping, on a massive earnings beat in March, FSLR has corrected somewhat; partly as a natural reaction to that sudden rise, but also dragged down by the general malaise among momentum stocks. The last couple of days would suggest that that decline has halted, but even if there is some more to come a return below pre-earnings levels looks unlikely.
A stop loss set to protect against a break below $54, therefore, would be logical and limit potential losses to around 10%. In the event that the decline is halted, then a return to the previous highs around $75 (a 25% gain) is the initial target. Obviously the risk/reward ratio here is in your favor.
CSIQ is a little more risky because of their debt levels, but once again represents a positive risk/reward scenario. Here the logical stop loss level would be just below $20, representing a potential loss of around 20%, but a return to previous highs around $44 would give an initial target of a profit over 80%.
Both CSIQ and FSLR represent the kind of opportunities that investors should look for. There is a compelling big picture case for the industry, supported by proven profitability in the individual companies and price levels that suggest a risk controlled trade. None of these things acts as a guarantee, but taking opportunities like this when they arise is just common sense.