2023-09-01 06:20:34 ET
Summary
- Clean energy surpassed coal in electricity generation in the US in 2022.
- Clean energy stocks have been underperforming, but this could be a good entry point for long-term investors.
- Research shows that green stocks outperform brown stocks, making them a promising investment option.
- Clean energy stocks are cheaper than the market in general while the expected earnings growth is bigger.
Clean energy is on the rise. Electricity generated from renewable clean energy sources - wind, hydro, solar, geothermal and biomass - surpassed coal for the first time ever in the US in 2022 according to the US Energy Information Administration.
Natural gas remains the primary source of electricity production in the US by a wide margin. But one day, clean energy will also surpass natural gas.
Despite the rise in power of clean energy, clean energy stocks are not performing great.
Should we throw in the towel given the current short term issues, or should we look across the valley?
Clean energy stocks down
The iShares Global Energy ETF ( IXC ) has outperformed the iShares Global Clean Energy ETF ( ICLN ) most of the time.
Only after the Covid-crisis, clean energy (massively) outperformed the S&P 500 (which performed itself rather nicely if we compare it with equity indices around the world). It also outperformed the "traditional" energy sector (that moved more or less in lockstep with the oil price).
The incredible rise in clean energy stocks after the covid-crisis (even called the " Green bubble ") was partly driven by Wall Street's SPAC frenzy (and we all know how that ended).
The past year, all clean energy ETFs underperformed the S&P 500. The best performing ETF was the SPDR S&P Kensho Clean Power ETF ( CNRG ).
But the underperformance was really outspoken the past weeks.
There are a couple of reasons for this underperformance. The rising interest rates hurt stock prices in general and higher beta stocks, including clean energy stocks, in particular. Clean energy stocks are longer duration stocks. You're not buying them because they're going to pay you a dividend in the next three months. You're buying them for the growth they will generate in the coming years. And longer duration stocks are more heavily impacted by rising rates.
Some clean energy stocks , like SolarEdge ( SEDG ) and Enphase ( ENPH ), got punished after the publication of their quarterly results. They got downgraded because their current-quarter guidance was below analyst expectations.
As a result, all clean energy ETFs are in a long term downtrend.
Should we throw in the towel given the current short term issues, or should we indeed look across the valley? Like we said, clean energy stocks are longer duration stocks and the current weakness in share prices could be a good entry point in this long term story. The Man Institute recently published some research that subscribes to this view.
Green vs. brown stocks
Research by The Man Institute shows that "green stocks can be expected to outperform brown stocks. The market persistently under prices risks caused by climate change, as is natural, as the risks tend to be far into the future". The research covers the period from 1 January 2008 to 31 December 2022 (and hence excludes the current period of underperformance).
For their analysis, The Man Institute used the Climate News Index calculated using RavenPack news headline data. The Climate News Index is calculated by counting the fraction of climate-related headlines out of all business articles in the rolling past 12 months, where climate-related headlines are defined as containing the following five key phrases: Climate Change, Global Warming, Greenhouse Gas, Carbon Emissions, IPCC.
Periods when climate concerns were increasing/decreasing are shaded red/yellow.
They looked at which stocks performed better when attention to climate change was rising, and which performed worse. Investors on average under react to public information on climate-change risks. Stocks positively exposed to the attention to climate change in the past ("green" stocks) outperform relative to stocks negatively exposed ("brown" stocks) by 5.9%
The degree of outperformance is empirically associated with investor attention to climate-change risks. However, "green" stocks still outperform "brown" stocks even when the attention is low.
The Man Institute sees two main competing economic rationales for climate-change risks and stock returns. In the first rationale, markets are efficient, and the return differences are due to risk exposures receiving compensations. Green stocks outperform because they are riskier. The second rationale starts from the view that markets are not efficient, and the return spreads between "green" and "brown" are mispricing due to investor behaviour.
For investors to be willing to hold a "brown" company in an efficient market, the expected return needs to be higher to compensate for the occasional unexpected pressure during intensified climate change attention periods. This implies that during the periods when climate change attention is low, "brown" stocks must be expected by the market to outperform "green" stocks. This is not what The Man Institute finds in the data.
Meanwhile, the behavioural bias rationale would postulate that the market generally overlooks the ramifications of climate change news, which leads to over-valuation of "brown" stocks relative to their respective true valuations - and vice versa, the under-valuation of "green" stocks. This is what The Man Institute finds in the data.
In conclusion, the two main findings of the research are:
- "green" stocks significantly outperform "brown" stocks.
- "brown" stocks do not outperform "green" stocks when climate change attention is low. We would expect brown stocks to outperform when climate change attention is low if markets were efficient.
SPDR S&P Kensho Clean Power ETF
We already mentioned CNRG is the best-performing Clean Energy ETF. With CNRG, you do not only get exposure to the clean energy theme, but also to the Artificial Intelligence theme. CNRG seeks, according to the SPDR website, to "track an index utilizing artificial intelligence and a quantitative weighting methodology to capture companies whose products and services are driving innovation behind the clean energy sector, which includes the areas of solar, wind, geothermal, and hydroelectric power."
Such stocks are mostly found in the sectors Utilities and Industrials.
When we drill down a bit we also find a noticeable weight for semiconductors.
The 10 biggest names in the ETF can be found in the below table.
Valuation
Three years ago, Clean energy stocks were valued in line with the S&P 500 on a forward P/E basis. One year later, clean energy was twice as expensive as the S&P 500 as you can see on the following chart from the Financial Times .
After the popping of the green bubble, clean energy's valuation came back to earth and clean energy stocks are after the recent weakness even much cheaper than the market in general. CNRG has a P/E of 15 and a P/B of 1.8, while the S&P 500 trades at a P/E of 23 and a P/B of 4.
We already mentioned clean energy stocks are longer duration stocks. You're not buying them because they're going to pay you a dividend in the next three months. You're buying them for the growth they will generate in the coming years. The figures confirm this.
CNRG has a dividend yield of only 1% (and the expense ratio of 0.45%). While CNRG is cheaper than the market, it has at the same time a higher expected earnings growth (24% vs 14%) according to SPDR.
Conclusion
In the battle between "old" and "new" energy, we expect that capital will keep shifting from traditional oil and gas investments to low-carbon clean energy alternatives.
Green stocks are currently cheaper than the market in general after the recent weakness, while they are expected to deliver higher expected earnings growth in the coming years.
Research shows that green stocks outperform brown stocks: Buying green stocks is both a "do good" (for the climate) and a "do well" (for your portfolio) strategy.
Our favourite clean energy ETF is the SPDR S&P Kensho Clean Power ETF. We think it's a good idea to look across the valley of the current weakness and to buy the dip.
For further details see:
CNRG: Both A 'Do Good' And A 'Do Well' Strategy