Renewable energy stocks offer investors a lot of conceptual or emotional appeal—but you need to know all the risks.
Renewable energy stocks have gained in popularity with investors over the past few years as concern over the environment has grown. However, many of these companies have limited investment appeal.
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The main reason is that most renewable power production relies on new technology and it’s necessary in most cases to rely on government subsidies to attract investors. Removal of these subsidies would make most renewable energy stocks commercially unviable.
Many governments around the world (including Germany and Spain) are cutting subsidies for renewable energy investments as they look for ways to deal with their slow economies.
To cut your risk, we recommend that you focus on renewable energy stocks that already have a sound base of other operations. That helps offset the risks of expanding into renewable-power production.
What are energy stocks?
Businesses that work in the extraction, refining and delivery of energy sources such as natural gas, oil, uranium and coal, are considered energy stocks.
Resource and commodity stocks in general should make up only a limited portion of your portfolio—say less than 20% for a conservative investor or as much as 30% for an aggressive investor. And as part of that segment, energy stocks could make up, say half of that total. The rest could hold fertilizer stocks, mining stocks and so on.
Oil and gas stocks have been below-average performers lately, and many investors are tempted to get out of the industry altogether. However, the energy sector can play a crucial role in your portfolio as a hedge against inflation. The low inflation rates of the past couple of decades deserve some of the blame for the poor performance of the sector. However, energy stocks will likely rebound in years to come as the global economy recovers.
When you invest in renewable energy stocks you face rapidly changing technology
Renewable energy stocks like solar power and wind power have dominated the green stock expansion of the past couple decades. Extensive investment in these areas has quickly moved the technology forward for their entire industries.
For example, advances in manufacturing techniques continue to steadily push down the prices of solar cells and solar panels. As well, alternatives to costly silicon, which is currently used in most solar cells, are emerging. These include technological advances like copper-indium-gallium-selenium solar cells.
As we mentioned earlier, focusing on renewable energy stocks that are solely focused on developing or making a single technology—and don’t have a source of conventional power production like hydroelectric or natural-gas fired plants to provide cash flow—adds a lot of risk.
That’s because they constantly risk being overtaken by competitors with a superior product. As well, customers may hold off purchasing their solar or wind equipment if they believe a new technology is about to emerge. For these reasons, we also think you would be far better off investing in companies with the research budgets to keep ahead of the competition and move quickly to embrace new technological developments.
4 tips and thoughts for investing in renewable energy stocks
Today’s energy projects call for a great deal of engineering, financial and political expertise. The top resource companies—like Imperial Oil or Encana—acquire a lasting competitive advantage by developing their expertise in these areas. This expertise is another type of hidden asset. It doesn’t appear on the balance sheet, but it gives energy stocks an advantage in every project they undertake. The same principles apply to companies with expertise in renewable energy such as General Electric.
Renewable energy stocks do sometimes turn out to have hidden environmental liabilities, as do companies in other industries. But the top stocks also create their own hidden assets. For instance, they accumulate rights to promising acreage for wind farms long before the land rush starts. They have the technical and political skills they need to foresee and deal with environmental and political obstacles. This hidden value can prove to be very profitable to investors who have a long term investment mindset as it can often take 20-plus years for the hidden value to reach its tipping point.
Successful renewable energy stocks pioneer technology advances with steady research spending. Successful investors now recognize that research and development spending is today’s best-hidden asset. Companies have to treat this spending as a day-to-day expense, much like maintenance or tax payments. So research spending comes right out of current year’s earnings. But when you do it right, research and development spending is more like a long-term investment than an expense. When it pays off, it can yield dramatic long-term dividends. In many cases, today’s seemingly high-priced renewable energy stocks are much cheaper than they appear at first glance, if you give them some credit for the funds they invest every year in research and development.
Renewable energy stocks may offer investors a lot of conceptual or emotional appeal. But most have problems that are easily overlooked. For example, if wind turbines are located in populated areas, noise from turning blades can spark public opposition that makes it difficult to win regulatory approval. The obvious solution is to locate the turbines in remote locations with steady winds. But that requires a bigger investment in long-distance transmission lines. A lack of transmission capacity has been one of many major problems with wind energy and wind projects.
What renewable energy stocks have you invested in the past? Were they profitable for you? Share your experience with us in the comments.
This post was originally published in 2016 and is regulary updated.
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