Alternative energy is a hot topic these days. With oil prices on the rise again and the Obama stimulus package making non-fossil-fuel development a priority, many investors are taking another look at firms in what could be an incredible growth industry.
But excitement about an industry that could be "the next big thing" can be dangerous. For proof, look no further than the early part of this decade, when investors poured into just about any tech and Internet stocks they could find, hoping they'd get in early on the next Microsoft (NASDAQ:MSFT) or Yahoo (NASDAQ:YHOO). Many such stocks soared in the short term but then came crashing back down to Earth, as it became clear that blind hope -- not fundamentals or a good business model -- were driving those stocks.
When I look at the alternative energy industry, I see a similar potential trap. Talk about declining oil reserves and government and popular support for energy independence sound good and are all good news for alternative energy firms. But for investors, none of that matters if a company doesn't know how to create products that are in demand, and doesn't know how to effectively -- i.e. profitably -- run a business.
When I recently ran a slew of alternative energy stocks through my Guru Strategies -- computer models each based on the approach of a different investing great -- I found that, unfortunately, most of these businesses have yet to prove that they can have the kind of long-term success that will reward investors. Not all of them fell short, however -- and one in particular caught my eye: GT Solar International (SOLR).
Based in Merrimack, New Hampshire, GT is no Johnny-come-lately; it's been in the solar power business for 15 years now, and is a leader in the production of polysilicon reactors and converters and multi-crystalline furnaces. Those products might not be ringing a bell, but they are essential technologies involved in making solar cells and panels. The firm has taken in $541 million in sales in the past year, and does a good deal of business outside the U.S., where solar technologies have gained a better foothold.
GT Solar gets high marks from the strategy I base on the writings of hedge fund guru Joel Greenblatt. In his 2005 bestseller The Little Book that Beats the Market, Greenblatt laid out a stunningly simple method that he had used to trounce the market -- one that uses just two variables. This "magic formula", as Greenblatt called it, produced back-tested returns of more than 30% per year over a 17-year period, about two-and-a-half times the return of the S&P 500 during that time. It's also treated me well: A 10-stock portfolio picked using my Greenblatt-based strategy has far outpaced the market since I started tracking it in 2005, and this year it has been my best performer, gaining 23.9%. Not too shabby during any market environment, let alone one in which the S&P is in the red.
Greenblatt's approach centers on a simple concept: Buy stock in good companies, and do so at bargain prices. To find good companies, he measured a firm's return on capital, and to find bargain prices, he used earnings yield. He ranked stocks in both categories (with the stock with the best earnings yield getting a score of 1, for example), combined the stocks' two rankings, and then chose those with the lowest combined numerical score.
My model works the same way, and it likes what it sees in GT Solar. The firm's return on total capital is almost 140%, which ranks 14th out of the thousands of stocks in the market. That meets the "good business" requirement.
GT Solar also appears to be a bargain. Its earnings yield is 18.2%, which comes in 90th out of all the stocks in my screening system. Its combined ranking is thus 104 (14+90), which overall makes GT Solar the second-highest-rated stock in the entire market, according to my Greenblatt-based model.
While companies like GT have had success, the solar industry is still in its relatively early stages, and a number of hurdles and challenges remain. But if you think solar power will have a place in the energy panorama of the U.S. and the rest of the world and want to profit from it, GT Solar looks like a good place to start.
Disclosure: At the time of publication, John Reese was long on SOLR.