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Solar Stocks Show Signs Of Recovery, But Will It Last?

|Includes: FSLR, LDK Solar Co., Ltd. (LDK), STP, YGE

The solar industry has been beaten up over the past few years from a perfect storm of problems affecting both the supply side and demand side. Tickerspy's Solar Stocks Index, which includes 23 different publicly traded solar companies, is trading down some 84.8% since January 1, 2008. But recently, many of these green technology stocks rebounded significantly from their lows.

The question for investors is whether this rebound is the beginning of a long-term trend or simply a fluke quarter. After all, the industry continues to face an oversupply of photovoltaic products, longer average selling prices, and ongoing concern over the future of European subsidies and falling crystalline solar prices.

Second Quarter Shows Improvement

The recent rally has been largely driven by positive second quarter financial results and bullish outlook from several large players. If these positive results continue, many investors see the sector's valuations as being far too low. Currently, Tickerspy's Solar Stocks Index shows an average P/E ratio of 10.1x and an average market capitalization of $292.7 million.

For instance, last quarter, First Solar (NASDAQ:FSLR) reported net sales that jumped nearly 50% versus its Q1 and year ago results. The company attributed the gains to an increase in the number and size of projects under construction that meet its revenue recognition criteria, including its Antelope Valley Solar Ranch 1 in California and the Silver State North project in Nevada.

Second quarter net income for the company came in at $1.27 per share, compared to a $5.20 per share loss during the first quarter and net income of $0.70 during the year ago period. Moreover, the results were impacted by a pre-tax charge of $36 million related to restructuring and other one-time costs that reduced its earnings by $0.39 per share.

Finally, the company offered strong guidance for the future, saying that it plans to achieve targets of 2.6 to 3.0 GW of sales in sustainable markets, earning a return on invested capital of 13% to 17% by 2016. As a result, the firm raised its revenue guidance by about $100 million and its earnings guidance by $0.20 per share for fiscal year 2012.

Analysts Remain Mixed on the Sector

Analysts remain very divided on the sector, which isn't surprising given the high level of uncertainty around the world. Falling photovoltaic prices have negatively impacted the supply side, while European subsidy cuts threaten to derail the demand side. Combined, these two factors have led to the dramatic decline in the sector over the past several years.

For instance, Chiense solar makers are expected to be hit by U.S. and E.U. anti-dumping tariffs that could further depress their sales. According to Frank Haugwitz, a renewable energy consultant in Beijing, "the next one and a half years will be very challenging." Companies like Suntech Power (NYSE:STP), Yingli Green Energy (NYSE:YGE), and LDK Solar (NYSE:LDK) have reported big losses.

Despite this downturn in China, some analysts remain very bullish about U.S. solar prospects. Lazard Capital Markets reiterated its Buy rating on FSLR with a $50 price target, while ThinkEquity also raised its rating from Sell to Hold with a $16 per share price target. But importantly, many analysts also note the many risks remaining in the sector.

The Best Ways to Invest in Solar

Investors looking to capitalize on the rebound in solar should keep a few things in mind:

  1. Wait for a pullback to avoid buying at the top and use technical indicators to identify the best times to buy and sell - the sector is largely driven by technical right now.
  2. Utilize options to limit losses by writing covered calls against a long position, purchasing protective puts, or simply using call options to capitalize on the movements.