Why There May Be Smoother Sailing Ahead For Solar And Wind Stocks

A good story often makes for a good investment. But not always. The green transition theme and the outlook for renewable energy make a compelling narrative, sure, and some EV stocks have posted huge gains, but solar and wind stocks have struggled lately despite their strong sales growth. So it’s worth taking a look at what’s driving those stocks lower and what it might take to turn the page…

What’s gone wrong with solar and wind?

The opportunity to invest in the newest technologies and biggest trends sounds exciting, but sometimes thematic investments can end up underperforming the market for long periods. And there are a number of possible reasons why this may happen, including super-slick marketing campaigns and ultra-high valuations. When stocks become expensive, it’s often because a theme is already well-known and well-followed, and that can lead to sharp falls when the thesis doesn’t go exactly to plan. That’s kind of what we’re seeing with solar and wind.

If you look at the share prices of the Invesco Solar ETF (ticker: TAN; expense ratio: 0.69%), the First Trust Global Wind Energy Fund ETF (FAN, 0.6%), and the Global X Uranium ETF (URA; 0.69%), you can see what happens when an exciting theme doesn’t produce stellar returns.

The solar ETF’s (white line) total return for the past year was a dismal -30%, the wind ETF (orange) was -6.5%, and the uranium ETF (yellow) was up just 6%. The S&P 500 (red), meanwhile, was up 14%. Now, those performances for solar and wind do seem pretty dire, but thematic investing should probably be considered over a longer time period. So let’s take a look at their 10-year performance.

As you can see from the chart, the solar and wind ETFs are up about 90%, the uranium ETF is virtually flat, and the S&P 500 is still leading the pack – and by a long way, up a massive 223%.

Clean energy stocks saw a strong rally after Joe Biden was elected president in 2020, with investors betting there’d be huge subsidies for green technology. But that momentum changed course over time, as higher interest rates caused funding costs to rise and longer-duration assets to drop in value. See, clean energy companies’ cash flows are expected to peak much further into the future than other companies. Higher inflation also played a role, causing production and shipping costs to overshoot initial projections. And competition from China in solar panels forced the industry’s prices sharply lower. What’s more, there’s been uncertainty about how hefty the tax credits will be from the US Inflation Reduction Act (IRA) and even some pro-green states like California have been thinking about reducing their environmental subsidies.

What’s the opportunity here?

The push toward renewable energy is set to continue for decades, with initiatives from governments around the world, including in the US, Europe, Japan, China, and India. Goldman Sachs calculates that growth targets implied from the IRA and Europe’s REPowerEU plan could translate into a combined addressable market for wind and solar that’s roughly $2 trillion in size. And the investment bank expects a steady and rapid expansion in renewable energy storage in Europe and the US by 2030.

Goldman says investors are still skeptical about the renewable industry's ability to create value from future investments though. And maybe that’s not hugely surprising: there have been a couple of gigantic profit warnings from leading wind providers Siemens Energy and Orsted. But the renewable business model isn't broken, the investment bank says, adding that current valuations actually provide a highly attractive entry point – especially in onshore wind and solar.

Goldman says these companies have learned from the recent market turmoil and are set to focus on value-creation opportunities – not sales growth – going forward. They’re taking more of a “slow and steady wins the race” approach: those big offshore projects in the US require around 25 different authorizations and those take time to get. When inflation was non-existent, the time delay wasn’t a huge worry, but when inflation rose, material costs jumped by nearly 50%, and that turned many projects into huge loss-makers. However, companies have started to adjust, hedging both their borrowing and materials costs to protect their profitability. And recently signed tenders have included full inflation “pass-through” provisions, allowing the companies to inflation-proof their revenues.

Thematic investing can be tricky, so diversifying your exposure to a few different themes may be the best way to go. Buying equities or ETFs when they have fallen a long way can sometimes stand you in good stead, giving you more attractive entry points. So right now you might consider buying some of the First Trust Global Wind Energy Fund ETF or the Invesco Solar ETF. Nuclear energy goes in and out of fashion when it comes to clean energy – and recently the price of uranium has been rallying, so that Global X Uranium ETF might be worth another look. Just be aware, despite its strong credentials for low carbon emissions, concern about the risks of nuclear energy will always remain.