Solar Energy ETFs: Don't Get Burned

With sky-high oil prices hitting new records seemingly every week, interest in solar energy burns bright. But investors have found shares of companies that provide solar-power gear to be among the most volatile in the entire stock market.

Shares of leading players like First Solar (FSLR) and SolarWorld (SRWRF.PK) routinely trade up or down by more than 10% in a day. On June 19, shares of Evergreen Solar (ESLR) surged 20% on news that the solar wafer maker had signed two long-term contract deals. But the next day, they dropped 8% when there was no significant news to drive the stock.

All that volatility had many investors welcoming the April introduction of two exchange-traded funds focusing on solar energy indexes, the Claymore MAC Global Solar Energy Index ETF (TAN) and Van Eck's Market Vectors Solar Energy ETF (KWT). The Claymore fund is already up to $163 million in assets, while the Market Vectors offering is yet to hit $25 million.

No Safe Haven

Unfortunately for investors, the ETFs have turned out to be almost as volatile as the individual stocks. Both were down more than double the Standard & Poor's 500-stock index's 1.7% drop on June 20. "Just buying the whole [solar] market means you just follow its ups and downs," says Morningstar (MORN) analyst Rick Hanna, who follows solar energy stocks. "If you do your homework, you should be able to do better than that."

That's because both funds are made up of mostly the same group of small- and mid-cap stocks. As of Mar. 31, First Solar was the largest holding in the indexes underlying both ETFs, comprising 9% of the Claymore fund and 11% of the Van Eck fund. Large-cap stocks generally don't meet the qualifications for the indexes underlying either fund, which require at least 33% of revenue from solar activities in the case of Claymore and 66% for the Van Eck fund. Index Universe Editor Matthew Hougan posted an in-depth comparison of the ETFs in April.

Much of the current solar business comes from Europe, where governments are giving generous subsidies and tax breaks to companies and individuals who install alternative energy equipment. The entire solar sector was roiled in May by rumors that Germany would cut back the subsidies. Many of the shares then had double-digit percentage gains when the German cuts, announced May 30, weren't as deep as expected.

Sky-High Valuations

Valuations of many solar stocks remain in the stratosphere—SunPower (SPWR) trades at a price-to-earnings multiple of more than 300, for instance—leading analysts to suggest that investors may be better off picking and choosing individual stocks to find the best opportunities.

Kaufman Brothers analyst Theodore O'Neill favors Akeena Solar (AKNS), which installs residential solar panels in the U.S. The stock has been excessively beaten down on fears that Congress won't do much to encourage solar usage, he wrote in a May 28 research report. Regardless of what legislators ultimately do, O'Neill thinks the growth rate in the company's underlying business makes the stock a buy.

Most solar panels used to generate electricity are made using large amounts of crystalline silicon, a substance much in demand. Morningstar's Hanna favors First Solar and Evergreen, which use a different technology to manufacture so-called thin-film panels using far less of costly raw materials like silicon wafers.

Playing the Suppliers

Another way to play the coming solar boom is by investing in top suppliers to the solar panel makers, Hanna notes. Applied Materials (AMAT) and MEMC Electronic Materials (WFR), which supply assembly materials to the solar panel outfits, "are like the people selling picks and shovels during the gold rush," Hanna says. Regardless of who finds the gold, investors who choose carefully in the solar energy segment could strike it rich.

Energy Stocks with Room to Run