America’s Energy Revolution: How to Spot the Winners and Avoid the Losers A Special Supplement to the Roen Financial Report 82 Church Street, Suite 303, Burlington, VT 05401 www.roenreport.com Toll Free (866) 799-8446 America’s Energy Revolution: How to Spot the Winners and Avoid the Losers To the Investor: Knowing how to pick the best companies in the volatile alternative energy sector is critical to being a successful energy investor. As President of Swiftwood Press LLC and editor of the Roen Financial Report website, I strive to bring you the best information on this dynamic industry, and offer specific guidance on how to determine which companies will be the next alternative energy stocks that are market winners. The Roen Financial Report provides you, the investor, with valuable information on alternative energy companies leading the paradigm shift away from foreign oil and polluting coal. Our website delivers timely, company specific information to help you make the right investment decisions. We track nearly 250 publicly traded alternative energy companies in energy efficiency, environmental services, fuel alternatives, smart grid, solar and wind, ranking the best investment prospects in each category. Also, the Roen Financial Report evaluates alternative energy mutual funds and exchange traded funds (ETFs) so that you can easily judge the top funds that fit your investment strategy. I am a financial writer with over 15 years of experience as a professional portfolio manager. My expertise is in finding high-quality alternative energy companies that are building a future less dependent on foreign oil and polluting coal. My investment experience allows me to cut through the hype using independent research and analysis, providing valuable information for my readers. I am not a financial advisor so do not offer individual investment advice, and no one at Swiftwood Press LLC acts as a broker for any investment product. My goal is to give you, the reader, essential information so you can make better investment decisions based on clear, deliberate strategies in an understandable, helpful manner. I sincerely hope you enjoy this report, and if you have any questions please do not hesitate to contact us at Swiftwood Press. Harris L. Roen President, Swiftwood Press LLC America’s Energy Revolution: How to Spot the Winners and Avoid the Losers I t is fair to say that humans will alHow to Spot the Winners ways need energy. The question is, what sources of energy will supply he Roen Financial Report tracks power to individuals, families, comnearly 250 companies in the panies and municipalities in the years to field of alternative energy— come? There is no one answer, but everything from the largest conclearly there is a paradigm shift underglomerates to speculative startups. How way, moving us away from traditional pedoes an investor choose the best compatroleum-based fuels and toward replacenies from such a wide list? ment sources that At the Roen Finanare less polluting U.S. Consumption by Energy Source cial Report, a variand not as conety of analysis 40% Biofuels Wind Energy strained by geopotechniques are Biomass Solar litical issues. combined to Waste 30% These emerging screen out the best energy sources prospects in the include biofuels various energy20% (ethanol, etc.), biorelated fields. The mass (wood and four most critical other fiber), waste strategies, which 10% to energy (trash can provide a baand other waste sis for a strong 0% products), wind portfolio of energy 2009 2010 2011 and solar (both companies, are heat-creating sys- Source: Energy Information Administration. listed below. tems and photovoltaics). Though natural gas has unre1. Track Alternative Energy Trends solved environmental issues associated There is no doubt that pressure to move with its production, it is also included away from fossil fuels is growing. The since it is much less polluting than coal energy mix that evolves will depend on or oil, and has strong domestic supplies. environmental, economic, technological, supply, and political factors. This report focuses on how to pick the Year Over Year Percent Change T best publically traded companies in these alternative energy fields, while also offering tactics that will help you avoid the losers in this volatile sector. Remember, always consult your financial professional before making investment decisions. www.RoenReport.com The chart above shows annual growth of the different renewable energy sources in the U.S. For example, wind energy (red bars) has increased 32%, 28% and 27% in each of the past three years. So while the rate of increase is decreasing, wind still has very robust growth. This page 1 growth is expected to continue, especially considering the imminent development of off-shore wind on a large scale. For solar, most activity globally been in Europe, but the pace of installation there is declining. Despite this, the widely followed analysts at SolarBuzz® report that growth in the U.S. and Asia/Pacific project pipelines will more than make up for the drop in European demand. For example, in 2011 solar in the U.S. had over double the growth rate than it did in 2010. Also, the U.S. Departments of Interior and Energy are moving forward with a plan to designate 17 “solar energy zones” in the southwest that could supply an additional 23.7 gigawatts of renewable energy. Despite this positive outlook, solar stocks have taken a huge hit in the recent past, mostly as a function of production outpacing demand for photovoltaic panels. This disparity, however, seems to be heading toward an equilibrium. SolarBuzz® is projecting that demand will outstrip production by the second half of 2012. The take-away is that if you are investing in alternative energy for the long-term, you have to be in wind and solar. Tracked Companies With High Relative PEs Ticker Company Name Sector Sector PE Average MXWL FSYS PANL ONNN AIXG Technology Consumer Technology Technology Technology 168 96 116 87 78 Maxwell Technologies Inc. Fuel Systems Solutions, Inc. Universal Display Corporation ON Semiconductor Corp. AIXTRON SE (ADR) 33.9 24.4 33.9 33.9 33.9 Tracked Companies With Low Relative PEs Ticker Company Name Sector Sector PE Average REGI MITSY CZZ JST GTAT Basic Mater Capital Goods Energy Technology Technology 4.5 5.1 6.0 5.3 3.5 Renewable Energy Group Inc Mitsui & Co Ltd (ADR) Cosan Limited(ADR) Jinpan International Limited GT Advanced Technologies Inc 19.2 24.2 34.2 33.9 33.9 Tracked Companies With High Relative ROE Ticker Company Name Sector TSLA VRSN SOLR NSM ACN Consumer Technology Technology Technology Services Tesla Motors Inc. Verisign, Inc. GT Solar International, Inc. National Semiconductor Corp Accenture Plc Sector ROE Average 61 44 41 38 35 9.2 9.9 9.1 9.1 9.9 Tracked Companies With Low Relative ROE Ticker Company Name Sector Sector ROE Average NUE Nucor Corporation Basic Materials-43 WFR MEMC Electronic Materials, Inc.Technology -87 SHCAY Sharp Corporation (ADR) Consumer -128 LYTS LSI Industries, Inc. Consumer -246 AES The AES Corporation Utilities -493 10.5 12.3 12.3 12.3 9.1 Table 2. High and Low ROE 2. Look For Excellent Financials. Market analysts use dozens of methods to measure the health and profitability of a company. One of the most useful and most analyzed is the price/earnings (PE) ratio. There are various PE ratios, but they are all defined as price per share divided by annual earnings per share. When the price per share side of the equation goes up PEs rise, therefore high PEs can be a sign of an overvalued stock. Table 1 shows which companies tracked by the Roen Financial Report currently have high or low PEs relative to their industries. Only companies trading at over $5/share are listed in order to eliminate some of the more unrealistic PE values. Since PEs vary by sector, it is important to compare a company’s PE to its industry peers. The top half of the chart shows high relative PEs, so these companies should be approached with caution. The bottom half of the chart shows companies with low relative PEs, which have a potentially more favorable financial outlook. Companies that list no PE are usually losing money, so are considered speculative stocks at best. Table 1. High and Low Relative PEs www.RoenReport.com page 2 Companies With High Relative Earnings Growth Ticker REGI AOS CZZ DAR IFSIA Company Renewable Energy Group Inc. A. O. Smith Corporation Cosan Limited(ADR) Darling International Inc. Interface Inc. Sector Basic Mater Technology Energy Consumer Consumer EPS Sector Growth Average 270% 11.3% 157% 10.5% 119% 18.2% 55% 13.0% 44% 13.0% Table 3. High Relative Earnings Growth Having a high return on equity (ROE) is another key indicator of financial health. ROE essentially shows how well a company can generate profit compared to the amount shareholders have invested in the company. Table 2 shows companies with high and low ROE relative to their sectors. Earnings per share growth, or earnings growth, can also be an extremely important tool in assessing a company’s overall prospects. Earnings growth looks at the earnings per share (EPS) of a company, which is the net profit a company has earned divided by the number of shares held by investors. Watching how EPS grows over time reflects well on how management is able to increase value for shareholders. Table 3 shows companies that rank high on earnings growth relative to other businesses in their industries. Debt is one of the most important indicators of a company’s long-term health. Debt in itself is not necessarily a bad thing—talented management can use debt strategically to drive profit in their businesses. Too much debt, however, can be problematic, especially if the economy experiences a downturn. At best the company may not have enough resources to cover its obligations and remain competitive; at worst, it could be forced into bankruptcy, in which case stockholders can lose everything. Three gauges of debt are used by the Roen Financial Report to assess a company’s financial health: total liabilities/ total assets; long-term debt/total capital; long-term debt/total sales. The three measures are combined using a proprietary formula to show an overall “Master Debt Rank” for each company. Table 4 shows the lowest debt for tracked alternative energy companies. Financial companies are excluded from the list, since they need to be measured differently. Loaning money, or debt, is part of their business, so high debt valuations for financial companies may not be detrimental. Note that 6 out of the 8 companies listed are in the Technology sector. This is because technology companies often get funded by venture capital looking to own a piece of the action, rather than banks making a loan. 3. Buy At The Right Price. One of the most important investment principles is to buy great companies at a good price. Finding great businesses is the easy part, but how do you know if its stock is overvalued or undervalued? Below is the methodology the Roen Financial Report uses to calculate “Fair Value” for each of the +/- 250 companies it tracks (click to see sample company profiles). Fair value is a measure of where a stock’s current trading price is in relation to a calculated fair price range for that stock. What is the best way to determine fair value? It is a question many analysts ask, and different forecasters use different methods. Some favor looking at what a company Master Debt Rank (below 10%) Ticker RBCN CREE UQM ZOLT OIIM DGII ABAT ERII Company Rubicon Technology, Inc. Cree, Inc. UQM Technologies, Inc. Zoltek Companies, Inc. O2Micro Int Ltd (ADR) Digi International Inc. Advanced Battery Tech, Inc. Energy Recovery, Inc. Master Sector Debt Rank Technology 7.1% Technology 7.7% Technology 8.2% Technology 8.8% Technology 9.1% Technology 9.4% Consumer 9.8% Capital Goods 9.9% Table 4. Low debt companies www.RoenReport.com page 3 4. Watch the Analysts. A consensus Table 5. Fair value calculations for POWI has done in the recent past, and so study “trailing” earnings. Others are more interested in determining a company’s projected earnings for the next few quarters or years, so they use “forward” earnings. Here at the Roen Financial Report we prefer to use a balance of forward, trailing, and current earnings as expressed in a company’s PE and EPS to get the truest picture of what its fair value should be. For example, at the end of March 2012 Power Integrations (POWI) looked like a good value. The math in Table 5, which is explained below, shows why this was so for POWI. When you average a combination of three years of trailing EPS, three years of projected EPS, and the current EPS for POWI at that time, it comes out to 1.44. This average EPS is used to calculate the fair prices. The bottom of the fair price range is determined by taking the median of annual PE lows for the past three years (20.48), and multiplying it by the average EPS determined above (1.44) to get a low fair price of 29.49. The top of the fair price range was similarly calculated by using the median of annual PE highs for the past three years (37.17) multiplied by the average EPS (1.44) to get a high fair price range of 53.52. The stock price at that time was 37.12, which placed it 32% of the way between the low and high fair price. This means that the stock was considered below fair value, which makes it a good investment option. www.RoenReport.com among analysts is another important indicator that a stock is in a favorable position for future growth. Experts from brokerage houses and analyst firms spend all day combing through stock data to pick companies that make the cut for their recommended “buy” list. More importantly, when a stock makes the list of several analysts, this can build an additional tailwind for a company’s share price to rise. In other words, people tend to notice what gets noticed. Of the 250 companies tracked by the Roen Financial Report, Table 6 shows those that are ranked highly in analyst recommendations. We use several measures to track analyst recommendations, then total them for one, two and three years. This is a good way to gauge a company’s current status, while also getting an idea how it is trending over time. Still, individuals should not take analyst recommendations alone and run with it. Many investors got burned in the 1990s when companies like Enron and WorldCom, listed as solid recommendations by many analysts, supplied numbers that were severely manipulated or just plain Highest Number of Analyst Ratings Ticker Company MSFT GOOG TEO CSCO VECO SRCL LNN ANDE ORCL THO ENS DAR LECO AVX Microsoft Corporation Google Inc Telecom Argentina S.A. (ADR) Cisco Systems, Inc. Veeco Instruments Inc. Stericycle Inc Lindsay Corporation Andersons, Inc., The Oracle Corporation Thor Industries, Inc. EnerSys Darling International Inc. Lincoln Electric Holdings, Inc AVX Corporation 3 year 2 year 1 year 52 51 67 56 43 63 46 57 49 60 36 60 47 60 52 47 53 56 43 38 36 47 42 54 36 60 45 55 34 34 33 31 30 27 27 26 26 25 25 24 24 23 Table 5. High analyst ratings page 4 false. Part of the problem was the built-in conflict when analysts of a firm were recommending a company while the investment banking team at the same firm benefited from a rising share price. Some of the problems of that arrangement have been addressed since the WorldCom days, but independent research is still advised. 2. Don’t Just Buy At Any Price. Remem- Avoiding the Losers But cheap PE does not necessarily mean the company is a good buy: poorly run companies can have a low price/ earnings ratio. So it is also important to independently determine fair value, as shown earlier in this report. I nvesting in stocks is not for the faint of heart, and even the best stock pickers have bad days. By having a coherent, disciplined investment strategy, one can avoid many of the pitfalls that less seasoned investors fall into. Below are four strategies to help you avoid mistakes in the market. 1. Know the Investment Climate. To evaluate potential low-quality stocks, an investor must analyze the macro economic environment. What are the financial and political trends? A technological or political development that benefits one industry sector may hurt another. For example, the discovery of a major new source of lithium—which is found primarily in briny underground aquifers—would help the battery sector by reducing costs and therefore prices. This would have a negative impact on the fuel cell sector, particularly fuel cell vehicle manufacturing. If batteries are cheaper than fuel cells, then the storage battery sector will grow more rapidly. Above all, try to see the big picture: where will this company be in five years? Is the company stuck with the old oil/coal industry, or is it moving toward new technologies? If you can get satisfactory answers to questions like these, you are much more likely to be in a good investment. www.RoenReport.com ber that an investment is not just a matter of a company being good or bad; it’s also a matter of the price you pay. If the PE is too high you may be overpaying and your chances of making a profit are diminished. By staying away from PE ratios above 20 or 25 you provide a cushion for any fall and leave more room for profits. 3. Diversify! Companies in the energy field run the gamut. They include large cap corporations and small cap startups; old legacy companies and emerging businesses; diversified multinational firms and focused single-product ventures. It is crucial to construct a portfolio that is diversified across many factors in order to generate balanced, long-term returns. One of the most important ways to classify a company is by size. In recognition of the differences in expectation between large and small companies, the stock market groups companies by market capitalization. Market capitalization (or market cap) represents the aggregate value of a company or stock, and is obtained by multiplying the number of shares outstanding by their current price per share. For example, if XYZ company has 12 million shares outstanding and a share price of $25 per share, then the market cap is 12 million x $25 = $300 million. But size is only one way to look at a company. Some companies are large, established highly diversified businesses within themselves, perhaps none more so than General Electric (GE). Based in page 5 Fairfield, Connecticut, GE has its roots in the 19th century laboratory of Thomas Edison in Menlo Park, New Jersey. Today, GE produces a vast array of products and services including appliances, aviation, consumer products, electrical distribution, energy, finance, healthcare, and more. Other companies are more finely focused, and more speculative. Western Wind Energy Corp (WND:TSXV), for example, is an electric utility purely powered by wind. Western Wind is currently generating 165 megawatts of electricity from wind turbines in California, Arizona and Ontario. It has an aggressive growth strategy that should increase its generating capacity substantially in the near term. Having said that, its current revenue stream is low, so investors in Western Wind are betting that the company will increase earnings. T Summary he future of energy will be a broad mix of uses, so your investment strategy should follow suit. The stock market investor following a long-term strategy needs to de- velop a portfolio that diversifies across types of energy production, various company sizes and locations, emerging technologies versus legacy providers, and so forth. Risk in one sector or company can be offset by lower volatility in another. The successful long-term investor will seek stocks with a consistently high return on equity; with a history of strong earnings growth; that’s well liked by analysts; with expert consensus that the company is positioned for growth, and is priced well. The key to long-term investing? Unless you want to roll the dice and gamble on one technology or a single company, you need to invest in a wide array of the highest quality companies, and continually monitor their financials to confirm their relatively dominant position. Through careful consideration and vigilance, the long-term investor can successfully capitalize on emerging energy trends. Important considerations such as risk tolerance, asset allocation investment horizon, and the like vary greatly from person to person, so individuals should consult their investment advisor before making any important financial decisions. Important Information “America’s Energy Revolution: How to Spot the Winners and Avoid the Losers” is a special supplement to the “ROEN FINANCIAL REPORT” which is a subscriber-only website with access at $149 per year published by Swiftwood Press LLC, 82 Church Street, Suite 303, Burlington, VT 05401. © Copyright 2012 Swiftwood Press LLC. All rights reserved; reprinting by permission only. For reprints please contact us at [email protected]. POSTMASTER: Send address changes to Roen Financial Report, 82 Church Street, Suite 303, Burlington, VT 05401. Swiftwood Press LLC is a publishing firm located in the State of Vermont. Swiftwood Press LLC is not an Investment Advisory firm. Advice and/or recommendations presented in this newsletter are of a general nature and are not to be construed as individual investment advice. Considerations such as risk tolerance, asset allocation, investment time horizon, and other factors are critical to making informed investment decisions. It is therefore recommended that individuals seek advice from their personal investment advisor before investing. These published hypothetical results may not reflect the impact that material economic and market factors might have had on an advisor’s decision making if the advisor were actually managing client assets. Hypothetical performance does not reflect advisory fees, brokerage or other commissions, and any other expenses that an investor would have paid. Some of the information given in this publication has been produced by unaffiliated third parties and, while it is deemed reliable, Swiftwood Press LLC does not guarantee its timeliness, sequence, accuracy, adequacy, or completeness, and makes no warranties with respect to results obtained from its use. Data sources include, but are not limited to, Thomson Reuters, National Bureau of Economic Research, FRED® (Federal Reserve Economic Data), Morningstar, www.RoenReport.com page 6