Solar's Silver Lining

There is not much going on in the stock market these days. It's hard to be bullish on any sector because the fundamentals remain awful, especially in the financial sector where it seems that tons of securitized garbage is still parked in their "off-balance sheet" books. (I must confess that I am not long financials and the only ETF that I will trade is the Ultrashort Financials proshares - the SKF).

But tonight I am not going to write about the miserable state of financials or about pension governance (I can just hear the collective sigh of relief from all those senior pension fund managers!). Instead, I want to focus on renewable energy, paying particular attention to the solar sector.

Let me first direct your attention to Charlie Rose's excellent interview with Amory Lovins, chairman and chief scientist of the Rocky Mountain Institute (click here to see the interview). Lovins has authored 29 books and hundreds of studies addressing alternative energy and the economy. I learned more about alternative energy and U.S. energy policy by listening to this one interview than by reading numerous articles and books on the subject over the past year.

Lovins discusses the fate of the auto industry and how GM's management was complacent and did not take the lead on creating cost-effective energy efficient cars. They had the technical know-how but only recently woke up to the fact that the energy markets have irrevocably changed. He states that one of the big three auto makers will not be around in 18 months.

Lovins hopes to see the next President of the United States adopt a "trans-ideological" approach in developing a sound energy policy. Interestingly, he cites the fact that from 1977 to 1985, the U.S. saved oil at a rate of 5% a year, breaking OPEC's pricing power for over a decade. Then, in 1986, President Reagan reversed the energy efficiency policies that dated back to President Carter and that this was one of the crucial structural changes that increased the U.S.'s dependence on foreign oil.

In terms of alternative energy, Lovins is not in favor of corn ethanol, stating that it makes more sense to make biofuels out of grass or wood chips. Like T. Boone Pickens, he is in favor of natural gas as a substitute to oil. As far as nuclear and coal, Lovins states that they are in real trouble because "it cost too much to build or run or both and their lunch is being eaten by alternatives that we were told would never amount to much." In 2006, "nuclear worldwide added less capacity than what photovoltaics added a tenth of what wind power added or a thirtieth or fortieth or what micropower added". According to Lovins, what this means is that nuclear would make climate change worse and you would get the result a lot slower. Interestingly, Lovins states that China is the world leader in renewable energy (in fact, solar energy will power some of the buildings at Beijing's Olympic village).

Again, it is an excellent interview and it is brief so take the time to listen and make sure you take down notes. There is no doubt in my mind that we are in the early stages of a long structural bull market in renewable energy. Investors should start focusing their attention on renewable energy and fuel cell technology. Wind power and solar power will be the future and there is tremendous growth that is going on in this sector right now.

One sector that has caught my eye is solar. I have been tracking a number of solar stocks and to my surprise, the whole sector suffered collateral damage as the stock market tanked in the last few months. But unlike financials, this pullback creates tremendous opportunities for investors that want to go long renewable energy. Listen to this Tech Ticker interview with Chris Nelder, an editor at EnergyandCapital.com and co-author of Profit from the Peak, who maintains that peak oil -- the concept that global oil production will soon decline sharply -- is fact, not theory.

Despite his gloomy scenario, Nelder notes that intensified development of renewable energy sources are inevitable. Nelder is not a big believer in "clean coal" and he is investing in renewable energy stocks, including wind and solar. Importantly, he states that he does not see any reason why solar stocks got whacked given their solid fundamental s and he does not think that solar shares should be coupled with oil prices.

Now, let me give you my take. I believe that hedge funds are playing solar stocks like a fiddle, which explains the extreme volatility in the sector. I have seen shares of many solar companies double, triple or quadruple in a very short period, then fall back hard after they report blow-out earnings and then head right back up. Many of these solar companies are profitable and even the ones that have no earnings yet are growing at such exceptional rates that it is only a matter of time before they become profitable.

The leader in the solar sector is First Solar (FSLR). They reported Q2 earnings after the bell today and they crushed earnings estimates. FSLR posted revenue of $267 million and profits of 85 cents a share; the Street had expected $216.9 million and 58 cents. In late trading, FSLR is up $19.50, or 6.8%, to $304.50. FSLR is considered to be a leader in the sector so barring some unforeseen event, I expect solar stocks to rally tomorrow. (You might want to know that America's richest family - the Waltons - own a huge stake in the company).

But FSLR is hardly cheap. It is currently trading at 130x trailing and 75x forward earnings. If you believe that everything regresses to the mean, either valuation has to come down dramatically or earnings have to increase dramatically so it starts trading at reasonable valuations. Other sector leaders like SunPower (SPWR) are also trading at high valuations. Nevertheless, they are growing exponentially and show no signs of slowing.

The good news for investors is that there are many other solar companies in the sector that are trading at reasonable valuations. One of my favorites is Solarfun (SOLF) but there are many others like LDK Solar (LDK), Renesola (SOL), Yingli Green Energy (YGE), Trina Solar (TSL), Canadian Solar (CSIQ), Suntech (STP), GT Solar (SOLR) and MEMC (WFR). And there are others like Evergreen Solar (ESLR), Hoku Scientific (HOKU) and China Sunergy (CSUN) that do not have earnings yet but are growing at a torrid pace (I particularly like Evergreen Solar's low-cost String Ribbon wafer technology). Here in Canada, I track a few other solar plays like Timminco (TIM.TO), 5N Plus (VNP.TO) and a speculative play on the Venture exchange called Opel International (OPL.V).

Apart from the naked short selling by hedge funds, the sector also got hit because governments are cutting subsidies but the technology has drastically improved, lowering costs so subsidies are not needed to maintain their growth model. If there is one silver lining in this crappy stock market, renewable energy stocks like solar shares are probably it. Keep an eye on this hot sector; despite the short-term headwinds, it is still in the early stages of a structural multi-decade bull market.