Shedding some light on the solar sector


(Editor's note: A version of this article appeared in optionMONSTER's Open Order newsletter on March 30. )

The ongoing nuclear crisis in Japan is giving some investors hope in the future of the solar-energy sector. It seems like such a common-sense thesis, but in reality is much less clear.

The biggest problem is that the solar sector is more dependent on government policies than sound economics. Some pay utilities for increasing their use of renewable energy, others give homeowners tax breaks to install solar panels, and still more pay small producers inflated rates for feeding electricity back into the grid.

You could spend the rest of your life trying to understand these policies. But the only thing you need to know is that they seem to be going away, as I discussed recently.

The main reasons are money, efficacy, and abuse. U.S. states and European countries simply don't have the resources to support "green energy," and in some cases big companies are manipulating the rules to get free money from the government.

"In light of recent abrupt policy changes in Italy coupled with regulatory dynamics in Germany, we believe pricing will fall faster than expected in 2011," Lazard Capital analyst Sanjay Shrestha wrote in a report this month. He predicted industry bifurcation as some companies rise to leadership and others fall by the wayside.

We've already started seeing evidence of these problems in company reports. Power-One, for instance, issued terrible first-quarter guidance on Feb. 4. ReneSolar followed with a forecast that was almost as bad on March 1. Late last month we heard similarly pessimistic noises from German heavyweights SMA Solar and Q-Cells.

PWER If there is ever a key message that readers should take from my columns it is the importance of identifying trends and betting with them. In the case of solar, we have pessimism from analysts and from companies. We also know that fiscal and political realities are driving this sentiment--and that means the trend is real.

We also know that, like chips, stocks in this sector trade closely in tandem with each other, so it's unlikely that one or two will make a ton of money as the others collapse.

Some optimists, however, point to the humiliating electoral defeat of Angela Merkel's party In March as a rebuke of her pro-nuclear policy. Surely this is positive for solar stocks, right? My answer is that a single vote in reaction to the very recent disaster in Japan will prove irrelevant over the long run.

I suspect that ending Europe's reliance on nuclear energy will be similar to closing the U.S. detention facility at Guantanamo Bay: easy for candidates to say before they get elected, but much harder to accomplish once in office.

Another important lesson from the solars is that multiples matter. Anyone looking at this sector will be stunned by the fact that several names trade for less than 10 times earnings despite enjoying triple-digit growth rates. This is a giant warning sign that something isn't right.

Stocks with real growth stories, such as Netflix and Illumina, often trade at extremely high multiples. Their earnings beat expectations, and their charts trend higher. These are the names to buy on pullbacks.

That brings us to the technicals, which aren't particularly good either because most solar names are trapped in ranges. LDK Solar, for example, might push back toward its recent peak around $14 and SOL might fill its March 1 bearish gap toward $11 or $12--but don't expect much more.

Trading opportunities do exist, but positions need to be managed very closely. This is not a buy-and-hold sector like natural gas or metals.

(Chart courtesy of tradeMONSTER)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing , Options

Referenced Stocks: LDK , PWER , SOL



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