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I’m interested in the solar and water sector as potential investments. It seems to me they’re bound to outperform with the focus on renewable energy and water shortages due to droughts. How can I navigate this sector?
L.S., Beverly Hills, Calif.
Dear L.S.:
There are sound reasons to consider companies that tend to generate steady cash flow (water) or promise environmentally friendly bulk power at low cost (solar).
But making a rational case for a particular type of investment doesn’t guarantee hefty returns. There’s always more to it.
“It’s great to identify sectors with great demand, and the structural demand for those two sectors seems right for a long period of time,” said Michael Rosen, chief investment officer at Angeles Wealth Management in Santa Monica, Calif. “But that’s just one element. The other is supply.”
Prices for solar panels are falling, which can decrease shareholder value of solar energy companies. Then there’s the risk of ever-changing technology. Many solar panels are made from silicon. But some companies design panels with other components such as cadmium or gallium that could provide a competitive advantage.
It’s hard to predict the evolution of solar energy in the coming years. Tomorrow’s advances could supplant today’s breakthroughs and lead to a mad chase for hard-to-obtain raw materials or costly new production facilities.
“Current solar panels could become obsolete as more innovation occurs in that space,” Rosen said. “I put solar panels on my house 10 or 12 years ago. Their efficiency is about half of what today’s solar panels can do.”
Even if you’ve identified promising sectors, you had better brace for a roller coaster ride if you’re going to own solar stocks. “Solar has been an extremely volatile sector,” Rosen said. “Water is a bit less so. It’s more consistent,” as you’d expect with a utility.
Allan Moskowitz, a certified financial planner in El Cerrito, Calif., understands both the appeal and the volatility of this type of investing.
“With more renewable energy mandates and water becoming a scarce commodity, they are good long-term investment themes,” he said. “But there’s more to it. I prefer not to invest in just solar and water because they’re too concentrated,” while mutual funds and ETFs with broader portfolios of clean energy offerings or commodities provide more diversification.
The more you dig, the more complicated it gets. Investing in water sounds simple, but it actually requires extensive knowledge and research.
“There are many aspects of the ecosystem, from water treatment to water supply to water equipment like pumps and pipes,” Rosen said. “And many water companies are regulated. They tend to be slower-growing with lower profit margins,” like you’d expect from any utility.
If you’re going to pursue solar and water investments, you need to examine how various market forces and business strategies may — or may not — impact specific companies within these sectors. “Is there a free lunch here?” Rosen said. “No, probably not.”
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