Why I'm Passing On Solar Stocks

For years, investors have been excited about the solar sector, and for good reason.

Few industries have had the massive growth potential at enormous scale that the renewable energy space does. Solar equipment was a nearly $190 billion dollar industry in 2022, and is expected to reach or exceed $306 billion by 2030, a 6.4% annual growth rate.

Frankly, I think it could do even better than that. The industry grew 20% annually between 2017 and 2022. 67 countries worldwide and 30 U.S. states have "mandatory" renewable energy policies in place, with targets ranging from 2030 to 2050. Solar is the second largest renewable energy source worldwide, behind only wind and slightly ahead of hydroelectric. Solar energy prices declined by 89% in the 2010's, putting it in a competitive economic position even aside from government subsidies.

The residential rooftop solar market in the U.S. has also continued to grow rapidly. Currently a $14 billion market, industry researchers expect it to reach $45 billion by 2030, representing a spicy 16% annual growth rate. This is another expectation I think could be met or exceeded, as electric vehicle adoption, declining home battery prices, and more attractive panel designs (that look like regular roof tiles) increase demand.

So given all these factors, it may come as a surprise that this article is about how I'm actually PASSING on the 5 solar stocks currently in the Green Screens.

Why? Let's have a quick look at each of these companies.

The 5 Green Screen Solar Stocks

Enphase Energy (ENPH): Enphase produces "micro-inverters" for home rooftop solar installations. These are a key component in the system, as they convert the DC current generated by solar panels into AC current that is used by all electrical devices in the home. The company has also dipped its toes into the battery storage and EV charger spaces, aiming to build out a portfolio of solutions for residential solar. Enphase is the only stock to appear on both the "Tortoise" and "Hare" versions of the Green Screens.

Array Technologies (ARRY): Array produces solar trackers, devices that tilt panels to achieve the greatest energy production for a given time of day and weather conditions (clouds, wind, etc.). Array sells mainly to utility-scale solar farms.

Shoals Technologies (SHLS): Shoals sells electrical balance of systems, or EBOS, for solar energy storage. Put as simply as I can, EBOS systems are all of the components that connect and transport power from solar panels to inverters and then into the electrical grid from a utility-scale installation. These are things like cables, fuses, connectors, combiners, monitoring systems, junction boxes, etc. Generally, Shoals sells solutions customized for entire systems instead of just a lot of separate components.

SolarEdge (SEDG): SolarEdge is a direct competitor to Enphase and operates a very similar business, with its main product being inverters intended for residential solar installations, but also branching into other home components like battery backup, EV charging, home energy management systems, and even lithium ion batteries.

First Solar (FSLR): First Solar is a leading producer of thin film photovoltaic (PV) solar modules, an alternative to traditional crystalline silicon solar panels. Thin film has several advantages over traditional panels: they are thinner, lighter, and more flexible, making them easier to transport and install. They are also less expensive to produce and more durable. However, they are also less efficient at collecting energy than traditional crystalline panels. First Solar sells mainly to large commercial installations and utility-scale solar.

The Problem With Solar Stocks

To quickly review, our strategy here is that a "green dot" stock exhibits all of the following characteristics:

• Excellent current and future prospects for above-average revenue growth (10%+ annually).
• Structurally recurring revenue, meaning individual customers pay the company many times over a short period of time.
• One or more economic moat factors: switching costs, network effects, brand, etc.
• Strong financial health with a proven ability to generate attractive free cash returns on capital.
• Proven leadership, preferably founder-led. What we don't want is "hired gun" CEOs.

Now, if we take that checklist and apply it to any of the above solar stocks, two points stick out like a sore thumb.

First, none of these 5 companies exhibit structurally recurring revenue. Any given solar project, whether it be a small residential installation or a huge utility farm, is going to generate big sales for these companies... but only one-time sales. Sure, there may (or may not) be follow up replacement or expansion needs, but those are unpredictable in both size and occurrence. We are not looking at a subscription or "toll booth" model here. After initial sales to a project, these companies will have to compete for any (smaller) follow-up sales once again. That makes revenues very unpredictable and subject to heavy competition for every dollar.

Second, it is hard to argue for any built-in economic moat for any of these firms. Clearly there are no switching costs, or network effects. Brand reputation may help some of these firms win sales, but it isn't a huge factor. The history of solar is one of constant technological change and foreign competition making profitability very difficult to sustain for a long period of time. Given the nature of these businesses, I don't see that changing any time soon.

The bottom line is this: these solar firms certainly have growth potential, and (at least at present) good financial health. But solar is a notoriously cutthroat industry, and they just don't have the two key characteristics that protect a firm in a competitive market (recurring revenue and moat). Given that, I can't recommend any of these, and they will be "crossed off" the Green Screen lists for consideration.