Wednesday, October 20, 2021

Stop worrying about solar stocks — they’re an opportunity cost too small

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Can stocks actually go up for the next five years?

I think it’s a dangerous assumption to make. My view is that this goes way beyond some simple “all stocks go up in unison.” Yes, I’d put myself in the camp that believe individual stocks and sectors may perform at an attractive pace over the next several years, and I’d have quite a few stocks lined up for that success. However, I think it’s a mistake to assume that the entire market goes up over a five-year horizon.

One clear example of that is the China-related equity markets lately. While China itself might be a “superpower” in the long run, it will likely continue to be a multi-century process. I contend that compared to other major market caps it will probably take twenty or more years for China to meaningfully displace the United States as the world’s largest market cap behemoth. This is not a doom and gloom thesis—rather I think this is a realistic and pragmatic view of the country’s current circumstances, as well as its potential future.

Somewhere between 2013 and now, however, the solar sector has been transformed. Perhaps it’s a good time to review the efficacy of a particular thesis when it’s hit so hard. Yes, there is more money moving into this sector than there has been in a very long time, and China has also adopted some of these same policies.

On paper, therefore, we would expect the entire sector to run up at least as fast as China itself has progressed, right? Not so fast. In some respects, I can understand how you could be concerned that some of the newer stocks aren’t getting the price appreciation they seem to be due.

There are at least a couple reasons I think the solar sector is looking a bit of a headwind. The first relates to the government’s dependence on low-cost solar systems. Since they are only a little less than twice as big as America, there is a very significant opportunity cost here. As we saw with sequestration, many in the government is terribly concerned about cutting budgets. Even if we consider solar as part of “alternative energy,” the sector in China has long been dependent on government subsidies, and many expect those subsidies to continue.

Many of the more promising companies in this sector come from a series of extremely cheap acquisitions, rather than intrinsic company growth. The Russian energy projects, which is one of the most advanced in the world, have a stated goal of having solar “be the dominant source of power.” For a company like Russia’s Novatek, which also happens to be worth well over $10 billion, that’s not a far-fetched goal. However, even the best developed firms in China look very easy to replicate at a much lower cost. A company such as Trina or Yingli, which recently quoted at $7.50 and $9.00 per share respectively, seem far from perfectly positioned for a wave of capital infusions coming their way.

Ultimately, I’m sure the solar sector’s financial performance over the next several years will largely depend on the technology’s adoption rate in China. Given how long that could take, and how much potential China may have, I don’t think the solar sector is quite ready to get its full load of speculative funds into it yet.

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