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  • Global interest in solar projects is increasing because of surging fossil fuel costs.
  • The Inflation Reduction Act includes a 30% tax credit on solar projects through 2032.
  • A solar ETF gives you exposure to the industry's tailwinds while reducing single-stock risks.

Winning stocks have been few and far between this year, especially when it comes to growth stocks. The rapid pace of Federal Reserve interest rate increases has driven Treasury yields higher, resulting in a revaluation of future cash flows lower. Alongside decelerating economic activity, the downward valuation adjustment associated with discounted cash flow models has taken a hefty toll on growth stocks, mainly because many boasted sky-high price-to-sales and price-to-earnings ratios last year.

Although most growth stocks have retreated because of rising rates, solar stocks have shined brightly. The late-cycle, inflationary spike in crude oil and natural gas prices has intensified with War in Ukraine disrupting global supply, causing heating and cooling bills to surge. As a result, international interest in renewable energy projects that increase energy independence and lower energy bills for consumers is climbing.

The tailwind behind solar energy strengthened further with the passage of the U.S. Inflation Reduction Act in August because solar installations will qualify for a 30% tax credit through 2032.

If you’re interested in riding the secular trend toward increasing solar deployments, you can buy individual stocks, such as Enphase (I wrote about that company here on July 27). Alternatively, you can spread risk across dozens of solar companies by buying Invesco’s Solar ETF  (TAN) .

In “Let's Shine a Light on the Best Way to Invest in Solar,” Real Money's Brad Ginesin argues the ETF offers advantages over individual companies.

He writes, “I believe the best way to play the solar sector is through the Invesco Solar ETF…When investing in this critical sector, many idiosyncratic issues emerge when analyzing individual solar-related stocks. Buying TAN eliminates the difficulty of picking winners and losers within the sector.”

Ginesin provides examples of the single-stock risk associated with buying individual solar stocks.

For instance, he explains that while demand is fueling revenue growth at Sunrun  (RUN) , it’s become a favorite target of short seller questions regarding its accounting. He also mentions that while Enphase  (ENPH)  is growing rapidly, it’s richly valued. He writes, “At a 70 multiple to earnings, having direct exposure in a volatile bear market can seem imprudent, but some exposure through TAN is far more palatable.” Furthermore, he mentions how uncertainty associated with regulatory decisions on imports and human rights concerns create risks for Chinese solar stocks, such as JinkoSolar  (JKS) . Also, challenges to intellectual property can cause stock-specific headwinds, such as recent litigation against Solaredge Technologies  (SEDG) .

Rather than taking on those individual stock risks, spreading exposure across many stocks participating in the industry could make more sense.

Invesco’s Solar ETF owns over 50 solar-oriented stocks, including top names like Enphase, which accounts for 11% of its portfolio. It also holds a basket of Chinese companies representing “about 20%” of its holdings. This diversification means you can still benefit from revenue and profit growth at these companies, with less worry you’ll wake up to discover you picked the wrong individual stock because of unexpected news.

Of course, diversification can mean lower returns because TAN’s likely to own some duds. Nevertheless, the ETF’s performance this year has been impressive. For example, its 5.4% year-to-date return trounces the S&P 500 and tech-heavy NASDAQ 100’s returns of -16.8% and -25.3%, respectively.

Its recent performance is compelling, too.

Since the lows in mid-June, it’s up 18%, approximately twice as much as the S&P 500 and NASDAQ 100. It’s also held up better since the mid-August sell-off, declining 5.5%, while the S&P 500 and NASDAQ 100 have fallen by 7.8% and 10%, respectively.

Back to Ginesin:

“As the effects of climate change become more stark, the solar industry will see a continued ramp up in demand from all regions of the world. Solar has proved especially critical as China, the western United States, and Europe were hit by mega-droughts that dried up hydropower output. In addition, tailwinds for solar demand abound: We have skyrocketing natural gas prices in Europe, grid unreliability from excessive summertime heat, government incentives from the Inflation Reduction Act, the electrification of transportation, and vast improvements in battery storage. Solar is proving a vital source of carbon-free energy.”

The backdrop supporting solar stocks is significant, yet investors could underappreciate it. For example, Ginesin points out that despite its stellar performance this year and the recently passed tax credit, TAN’s assets under management have declined to $3 billion from $4 billion last November.

The Smart Play

The general market sell-off and lowered valuations caused by higher interest rates are likely depressing interest in solar stocks. However, that could create an opportunity, allowing us to buy them at favorable levels before stocks find their footing and interest in growth stock returns.

In the first half of a bear market, it pays to shorten time horizons on longs and lengthen time horizons on stocks you’re short. In the second half, the opposite is true. The Fed is still hiking rates, so it remains investors’ foe rather than its friend. However, the year before a Presidential election is historically bullish, and front-end loaded rate hikes could mean the Fed moves to the sidelines by year’s end if inflation trends lower. If so, we could be closer to the back half of this bear market, making it wise to buy stocks selectively.

Instead of adding beaten-down stocks with lots of trapped sellers eager to sell rallies to portfolios, focusing on leaders, such as solar plays, could be better. After all, it’s a good sign when a growth stock does well when everything else acts poorly.

It could be a good entry point if you want to buy the Invesco Solar ETF. It still trades above its 200-day moving average, and the recent pullback means it's converging with support at its up-trending 50-day moving average. However, there’s a gap that it may fill at about $77, so consider breaking your buys up into multiple transactions. For example, you could buy some here at the 50-DMA, add some if it retreats toward $77, and more if it retests its 200-DMA near $74. Then, you can place a stop loss below to protect yourself if you’re wrong. 

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