Clean energy saw stellar returns throughout 2020. This growth included the companies themselves, as well as their stocks and clean energy exchange-traded funds. According to the International Energy Agency, approximately 90% of new energy generation in 2020 was renewable, with gas and other non-renewables accounting for only 10% of new energy. Meanwhile, over the course of 2020, the iShares S&P Global Clean Energy Index Fund (ICLN, Financial) ETF returned 142%.
However, as 2020 rolled into 2021, investors began to sour on clean energy, causing stocks in the sector to plummet. Over the past month alone, solar and wind ETFs are down 24% and 16%, respectively, even as the non-renewable energy sector is up 24% on average.
Why the sell off?
There are two main reasons for the sell off. The first is that many no longer see clean energy as the more attractive investment compared to fossil fuels. In 2020, a global oversupply of fossil fuels combined with the massive debt of many oil and gas companies meant that profits were shrinking and the future of specific companies in the sector was uncertain. In comparison, clean energy continued to grow due to demand greatly exceeding supply, causing a transfer of optimism from fossil fuels to clean energy. As the world begins to recover from the Covid-19 pandemic, oil prices are rising again, attracting investors back to non-renewables in droves.
This leads us to the second main reason for the clean energy sell off – overvaluation. Clean energy is expected to eventually supplant non-renewables in the long run, as the world only has a limited supply of fossil fuels (and their consumption impacts the environment). This long-term optimism means that investors have been willing to grant much higher valuations to clean energy stocks in recent years, anticipating their investments to be worth much more a decade or so down the line. However, as with all high-growth, high-multiple sectors, this leads to price volatility; the higher valuations get, the more room they have to drop if market sentiment turns against them. Additionally, it becomes harder for investors to tell the long-term winners from the duds when profits are increasing across the board.
The case for clean energy investing
Despite short-term headwinds to stock prices, the outlook for the clean energy sector is favorable. According to projections from the U.S. Energy Information Administration, generation from renewable energy sources in the nation is expected to rise from 20% in 2020 to 21% in 2021 and to 23% in 2022. Most other major economies are expected to outpace this growth, including China, Canada and much of Europe.
Given the long-term factors supporting the growth of clean energy, investors could do well taking advantage of the recent selloff to pick up shares of clean energy ETFs or the individual stocks of leading industry players.
In terms of assets under management, the above-mentioned iShares Global Clean Energy ETF leads with $1.38 billion in assets under management. This ETF is diversified both globally and in terms of the types of renewable energy stocks it owns, so it is a good option for investors who want broad exposure to the sector.
The Invesco Solar (TAN, Financial) ETF is another popular ETF, with a focus on solar rather than other types of renewables. Solar has the biggest residential addressable market, as most homes can have solar panels installed on the roofs whereas a wind turbine would likely not be permitted by the homeowners' association. It had seen stunning 234% returns at one point this past year before the selloff began, which took off 24%.
For investors looking more at wind energy, the First Trust Global Wind Energy (FAN, Financial) ETF is an option. Wind is known to be a far more efficient power source than solar, consuming less energy, producing less CO2 and producing more energy overall. Thus, it has higher potential for growth on the utilities scale. The ETF returned 63% in 2020.
ETFs are typically a safer option than individual stocks for investors who want to get in on the macro trend without doing research into specific companies. However, for those looking for specific companies in the clean energy sector to invest in, a good place to start is to search for industry leaders that have a strong balance sheet and positive operating margins.
According to the GuruFocus All-in-One Screener, a Premium feature, three stocks with positive operating margins, a market cap of at least $1 billion and financial strength and profitability ratings of at least 5 out of 10 are First Solar Inc. (FSLR, Financial), Orsted A/S (DNNGY, Financial) and Xinyi Solar Holdings Ltd (XNYIF, Financial).
First Solar is an Arizona-based semiconductor company that manufactures solar panels and utility-scale photovoltaic power plants. It also provides supporting services for its systems, including maintenance, construction, financing and end-of-life panel recycling. It is the leading global provider of utility-scale solar power systems. It has a market cap of $8.75 billion, an operating margin of 11.93%, a financial strength rating of 8 out of 10 and a profitability rating of 5 out of 10. According to the Peter Lynch chart, the stock is trading in line with its intrinsic value after the recent decline in price and rise in earnings.
Orsted is a Danish multinational renewable energy provider. It specializes in offshore wind, but also produces energy through onshore wind farms, solar farms and bioenergy plants. Orsted provides energy to clients in several countries in Europe, Asia and North America. It has a market cap of $65.23 billion, an operating margin of 20.58%, a financial strength rating of 5 out of 10 and a profitability rating of 5 out of 10. The Peter Lynch chart indicates it is still trading slightly above its intrinsic value despite recent declines.
Xinyi Solar Holdings is a Chinese investment holding company that primarily manufactures and sells solar glass. It is also involved in the operation of utility-scale solar farms and provides engineering, procurement and construction services for solar farms. It has a market cap of $16.85 billion, an operating margin of 47.82%, a financial strength rating of 7 out of 10 and a profitability rating of 8 out of 10. Following the recent declines, the stock is still trading above its intrinsic value according to the Peter Lynch chart, but it is in line with its average historical valuation.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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