We humans like to invest in green technology companies. They are some of the most innovative companies. They get government support. People buy their stocks and their products just because they are green. They are literally helping to save the world.
But that doesn’t mean you should pay too much for the stock. Over and over, retail investors have made naive decisions to buy into green companies with sky high valuations. It’s not just the naive retail investors doing it. Governments and institutional investors have also been burned many times.
What should you do? You need to think like a venture capitalist, because when you buy into a development stage green technology company, that is essentially what you are. But you should know that in exchange for taking on a lot of risk, venture capitalists look for companies that can return 35, 40 or 50% per year.
Venture capitalists NEED that kind of return because they know that a high proportion of their risky investments will never pan out. Out of their portfolio of high risk stocks, one or two will pay off really well, a few will be marginal, and several will be failures.
Unfortunately, most stocks on the US exchanges are priced to return on average 5-15% per year.
Are you a better stock picker than a venture capitalist? Can you avoid the failures better than they can?
Retail shareholders generally have no special skills at picking stocks. They don't have special access to company information. Most don’t know how to calculate the potential return. They don’t know how to put a value on a stock. Often, they depend on broad general sweeping statements or narrow observations about the stock price.
- Electric cars are the future!
- The CEO is a genius! Look what he did for Consolidated Cookies!
- Natural gas is cheap and supplies are increasing!
- The stock can’t go any lower – it's dropped by 90% in value in the last year!
Take Tesla Motors (NASDAQ:TSLA) as an example. At current prices, to justify a 30% return on investment, Tesla would need to grow its revenue at a 65-70% annual rate every year for a decade (and be profitable). How many companies have ever grown at 65% for a decade? But electric cars are the future!
Westport Innovations (NASDAQ:WPRT) is another example. Westport makes technologies that use natural gas. To justify its current price, and to get a 30% return on investment, Westport would have to grow at a 60-65%% annual rate every year for many years to come. Again, how likely is that? Given that the last five year sales growth has been 32% including acquisitions, that seems very optimistic. But natural gas is cheap and supplies are increasing!
Sadly, very few public companies are priced to give you a 30% return. Tesla and Westport are no exception. We would argue that you are accepting way too much risk for way too little return when you buy those stocks.
Tesla and Westport may end up as successful companies. They may make good products, and probably will be around for many years. We hope that they will be successful. But that doesn’t mean you should invest at the current prices. If you want to contribute to a greener world - then buy their products.
Eventually the market catches up on valuation mistakes. When the growth doesn’t keep up with the hype, the usual result is a gut wrenching price drop. Famous failures in the past have included Sirius (NASDAQ:SIRI), Iridium before it was bankrupt and reborn, and Clearwire (CLRW).
Generally, the stock market does not adequately reward small investors for taking on a big risk. The wholesale investors and the venture capitalists often get special deals that you and I will never see. Even then, the professionals usually walk away.
Most green energy stocks are in the high risk, development stage. Unfortunately, very few green stocks are priced to give you the high return you should be looking for. Typically, they need to be small, largely unfollowed companies that are under-the-radar of the bigger investors. You have to research carefully, and you can’t depend upon high profile analysts. If the high profile analysts are following it – by definition, it's not under-the-radar.
These rare finds might include technologies that are out of favor (after some high profile failures), or brand new technologies. Often the stock we like has already taken a big beating (sometimes 80% or more), but the company looks like it is on track to reach positive profitability, or be acquired within 1 or 2 years.