Theme investing can pay off from time to time. Today’s popular investment themes include alternative energy, such as solar wind and geothermal, and emerging markets, such as China and India.
However, theme investing can turn out badly for investors, especially those who get in late or forget about investment quality.
The reason why is straightforward. When you indulge in theme investing, you allow a theme or concept to take a central place in your investing decisions. Usually the theme or concept includes some prediction about the future that has some truth in it, and will make noticeable changes in society. You may assume that if you can just get aboard that theme or find an investment whose future is tied up with it, you are bound to make money.
In other words, you are buying what you might call a “Big Idea” without making certain that a particular investment has a workable business concept, or the management strength and financing it needs to overcome competition and profit from it.
Our investing advice? Focusing on a theme can cause you to overlook crucial details
A key problem is that if the theme is your overriding investment consideration, it’s all too easy to get sloppy about the details. You may come around to the view that the theme is so powerful that you can safely disregard p/e ratios and other measures of value and risk. You may wind up basing investment decisions on offhand projections or self-serving investing advice from promoters.
Mind you, facts support most popular investment themes. Keeping those facts in mind can help you spot stocks with extra potential. But if you let the theme make the decision for you, you are sure to overlook risk.
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Investing advice: How we analyze stocks that are part of a popular theme
Before we give any investing advice on stocks that are part of a popular theme, we always look for clear signs of investment quality.
For example, the theme of renewable energy has become more popular in the past few years, as concern over the environment has grown. However, like all investment themes, our investing advice has always been that you must choose your renewable-energy investments very carefully to profit. That’s because many of these companies have only limited investment appeal.
These firms often need a long time to move from the research or concept stage to profitability. As well, high government deficits cast doubt on how long governments will keep paying subsidies for renewable energy development.
To cut your risk, our investing advice is to focus on renewable energy stocks that already have a sound base of other operations, preferably businesses that provide steady revenue streams. That helps offset the risks of expanding into renewable-power production.
NextEra Energy Inc. goes far beyond the renewable-energy theme
NextEra Energy Inc. (symbol NEE on New York), formerly known as FPL Group, provides an example. NextEra is one of the companies we analyze in our Wall Street Stock Forecaster newsletter.
NextEra owns Florida Power and Light Company, a regulated utility that sells electricity to 4.5 million customers in eastern and southern Florida. It also owns NextEra Energy Resources, which operates unregulated power projects in 28 U.S. states and Canada. This subsidiary is also the leading wind-power producer in the U.S.
Steady income from NextEra’s regulated power operations in Florida helps offset its less-predictable wind- and solar-power projects. As well, its expansion into other parts of North America cuts its reliance on a single region.
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