Back in April 2006 we posted “The Photovoltaic Boom ,” where we enthusiastically reported the bright future of photovoltaic power.  We thought then, and we believe now, that photovotalic production will increase faster than projections, at the same time as costs will fall faster than expected.  But if photovoltaic power is becoming a commodity, doesn’t that mean the stocks of photovoltaic companies are also going to acquire the characteristics of commodities stocks? 

Here in the summer of 2008 we may very well have a photovoltaic bubble.  It may be that photovoltaic stocks have nowhere to go but down.  Rather than attempt to compare and contrast the entire sector, simply consider the fortunes of First Solar, a company we enthusiastically reported on back 6-27-2001 in a report entitled ”First Solar, the Model T of Photovoltaics.” 

One might characterize First solar as a “proof of concept” company, among other things.  This means First Solar is the first company to produce market-worthy production volume low cost thin film photovoltaic cells, strata with lower efficiency than with proven crystaline technology, but better low-sunlight performance and greatly lower cost.  The problem is First Solar is decidedly not “last solar” when it comes to thin film technology, or photovoltaic technology in general.

With the willingness of governments to subsidize solar power waning in the face of production volumes of photovoltaic modules exploding, where should First Solar’s stock rest?  Clue:  It is manufacturing what is becoming a commodity, one that still employs significant incremental cost advantages for each year the installed capital is more recent.  Unless First Solar can continue to innovate their way into a clear technological edge that translates again and again into reductions in manufacturing costs, their stock multiples will not withstand the tsunami of photovoltaic production investment that inundates the world.  With companies like Applied Materials shipping literally dozens of factories to produce thin film and monocrystaline photovoltaic modules each year, and countless other conglomerates from Asia to Europe to America doing likewise, as the years pass, First Solar competes uphill, not downhill.
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Vespula flavopilosa

Nowhere is this disparity, this dissonance, reflected so much as in First Solar’s stock price.  As of the close of trading on 7-25-2008 First Solar’s stock was trading at $265.46.  Is this overvalued?  First of all, this price for a single share, multiplied by the number of shares outstanding in First Solar, means the “market price,” the cost one would have to pay to own 100% of the stock in First Solar and own 100% of the company, as of the close of trading on 7-25-2008, was not quite $21 billion.  Is $21 billion a fair value to own the entire company?

One important way to determine if a company is overvalued is not to look at the price/earnings ratio of their stock (or for the entire company, the ratio of their market value to their annual net income), but instead to examine their stock’s price/sales ratio (or for the entire company, the ratio of their market value to their annual gross revenue).  Relatively thin profits, as a percent of revenues, means most major corporations display volatile earnings, rendering their price/earnings ratios less reliable indicators of their financial prospects.  It is far more difficult for a corporation to manipulate their gross revenue than their net profit.  Bottom line, if a company like First Solar’s stock has a trailing twelve-month P/E of 104.4 as of 7-25-2008, one needn’t necessarily be alarmed, even though producers of commodities generally have much lower sustained P/E’s, to put it mildly.

With the price/sales ratio, however, it becomes clear that if First Solar’s stock price is representative of the photovoltaic sector, we could have a bubble on our hands.  First Solar’s trailing annual revenues are $634 million, which with 100% of their stock costing 20.93 billion, means their price/sales ratio is thirty-three.  For First Solar’s sales to grow into a typical manufacturer’s price/sales ratio (with no increase in the price of their stock) is no easy feat.  For their price/sales ratio to come down to the still ridiculously high commodities manufacturer’s multiple of 5.0, their annual sales would have to grow to $4.2 billion.  For their price/sales ratio to come down to the conservative multiple of 1.0, First Solar’s sales per year would have to jump to $21 billion.  It’s certainly possible, but worthy of at least the scrutiny cellulose commands.

There is no reason to think First Solar can’t beat the odds, and stay in the horse race all they way to becoming a $21.0 billion company (annual sales).  But given their current inflated multiples, it is very unlikely their stock is going to grow the way it has to-date.

There is also no reason to doubt worldwide photovoltaic production will continue to experience growth beyond projections.  When all it takes is sand and electricity to produce photovoltaics, with an energy payback of 20+, this sector will grow with or without subsidies, mandates, grants or preferences.  Only the ineluctable success of the market is necessary to deliver photovoltaic abundance, and bubbles are only bumps in the road.  Investors watch out, however, you may skin your knee.