Is It Time to Buy SolarCity Stock?

SolarCity is not only one of the most talked-about stocks in the solar industry, it's one of the most revolutionary companies in America today. It's redefining the way we think about energy and turning your average household rooftop into a moneymaking asset, something it's never been.

After rising five-fold since its IPO, the question is whether the company is poised for long-term stock market gains or if investors should watch from the sidelines. Let's take a look at SolarCity's future and how it's valued versus competitors.

Source: SolarCity.

The manufacturing strategy also further vertically integrates SolarCity and puts it in direct competition with SunPower, which is one of the largest residential solar installers in the world, providing panels, financing, and other services to installation partners. When combined with Vivint Solar, which is expected to go public this fall, these are really the three companies battling for the residential solar market today.

Long term, there are two levers SolarCity can pull to create value: increasing installations and making more money on each installation. When it comes to growing installations, SolarCity is firing on all cylinders.

Small commercial installations have been added to SolarCity's business in recent years.

Long-term value creation

When SolarCity installs a solar system, it signs the customer to a long-term solar lease. The value created for shareholders is through the excess cash flow from those lease payments minus the costs paid to build a system. SolarCity judges itself by the present value of these cash flows in a metric called called retained value.

As of the end of Q2 2014, retained value was projected at $1.8 billion and grew over $500 million last quarter alone. What's amazing is that retained value per watt grew to $2.32 last quarter, the highest we've seen since SolarCity went public.

What SolarCity has been able to do is lower installation costs faster than anyone anticipated by standardizing things like racking, inverters, and solar panels (through the Silevo acquisition). As these costs continue to fall, the company will remain competitive with others in the solar market -- even if financing structures transition to loans or cash sales.

The unknown is whether or not SolarCity will be able to maintain anywhere near $2 per watt in retained value with installation costs falling and competition increasing. I expect consumers to switch to buying solar systems with lower margin cash or loans, reducing some of the value SolarCity can generate per watt.

So, while installations will grow rapidly, the value created per watt installed will likely fall. That's to be expected in solar, but it also makes valuing the company very difficult.

SolarCity workers install a residential solar system.

SolarCity isn't cheap, but it may be worth buying

SolarCity has done a great job selling the market on its retained value model, and if we go on that alone, the stock is a fair value. Through the end of the second quarter, the company averaged $1.72 per watt in retained value and $1.8 billion in overall retained value on the books. If we multiply the per watt retained value by the projection of up to 1 GW of installations next year, we could see $1.72 billion in new retained value in 2015. Even if we subtract $400 million for operating costs, the retained value added minus operating costs could be around $1.3 billion.

A $6.6 billion market cap puts the stock at just 5 times forward potential retained value minus operating costs. When you consider the company's growth trajectory, this could be a conservative price if the market doesn't change significantly.

But that's where SolarCity will run into challenges. It's still not profitable, and the valuation metrics I've used above are based on 20+ year projections that may or may not come true. Plus, long-term competitors will begin taking more market share, and I think the industry will transition to loans or cash sales that are far lower margin per watt. $2 per watt in value creation is a pipe dream a few years from now.

If you're looking for a lower risk solar investment, SunPower makes the industry's highest efficiency panels and is profitable, something SolarCity can't say. The stock trades at 25 times trailing earnings, and that's before including nearly 300 MW of solar projects that have been built on the balance sheet. It won't be the growth company SolarCity is, but it has real profits to point to and already makes solar panels, so it doesn't have the risk associated with SolarCity's manufacturing plans.

Foolish bottom line

With all of these factors considered, SolarCity's sheer scale and cost advantage won't be easily replicated by anyone in the solar industry. SolarCity is a cost and innovation leader, and while it isn't the safest stock, it has a tremendous growth opportunity. At a $6.6 billion valuation, I think investors who buy and hold for the long term will do very well. Just keep in mind that the ride can be bumpy, so a long-term view is necessary as SolarCity builds out the vision Elon Musk and team see over the next decade.

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The article Is It Time to Buy SolarCity Stock? originally appeared on

Travis Hoium manages an account that owns shares of SunPower and is personally long shares and options of SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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

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

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