In spite of overwhelming evidence pointing to ongoing changes in our climate, the “debate” on climate change continues. Climate, despite what you may have heard from some quarters, is indeed changing. And while the basic high school physics of “carbon dioxide traps infrared heat” seems to make this change inevitable, all the politically driven wrangling is a sideshow to what’s going on all over the planet. And what’s going on with climate is having very real impacts all along the economic value chain.
Whatever the direct cause, ice is melting, water is becoming more scarce, and global agriculture struggles to keep pace with increasing demand and climactic obstacles to supply, to cite just a few examples. Extreme weather is also hammering us: 2011 has already set records –– in both dollar and absolute terms –– for most weather related disasters ever in the U.S. That has big implications for future economic growth.
Consider this quote: “In July, reinsurance giant Munich Re predicted that 2011 –– on the evidence of the first six months alone –– will be the costliest year ever for disasters triggered by natural hazard. Total global losses by June had reached $265 billion, far outstripping the $220 billion record set for the whole of 2005.” In case you forgot, that year included $82 billion for Hurricane Katrina alone.
Our fossil fuel economy got us here, and that economy has to change. We can debate the speed of that change perhaps, but further major economic and climatic events are an inevitable consequence of the fossil fuel driven economy. When and where future events will take place is unknowable. But knowing they’re coming, and that change in general is occurring, provides an advantage in that we can invest early in the best “next economy” remedies. This approach could perhaps be best described as “Anticipating (versus reacting to) the next black swan.” Or as Walter Gretzky famously taught his son Wayne, “Skate where the puck’s going, not where it’s been.”
Careful Stock Picking Required
So how do you invest for that? For us, the answer is to get in front of the primary problems. Namely, to identify the most pressing issues facing civilization –– the ones that will need to be addressed first and at the largest scale –– and then to look for the technologies, systems, and approaches that have the best chance of mitigating those problems at the lowest economic cost.
This sometimes leads us to what many investors think of as “green stocks,” such as renewable-energy companies.
But simply buying “green” stocks is no panacea. Just as with today’s economy, the new economy requires careful stock picking. The companies and technologies may be new, but the tools of valuation remain the same. The basic questions still stand: Does the company make money? Is it growing? Is it in a rapidly expanding sector? Do we think management is solid? If all of these things appear worthy, do we think the company is a good value at this price?
This approach will be quickly recognized by most as the value-focused Graham-Dodd-Buffett school of company valuation. It’s a philosophy to which we’ve very closely hewn.
For example, consider Chinese solar manufacturer Canadian Solar (CSIQ), a vertically integrated solar firm –– meaning it has superior cost control and less margin risk –– providing everything from raw polysilicon to installed PV systems. Canadian Solar expects to net US$.61 per share in 2011, and $.80 in 2012. It’s a nicely profitable and growing little company, yet its value metrics make it look like it’s burning rather than making money: price-to-earnings is 2.9; price-to-sales is 0.01; price-to-book is 0.29 and it’s trading at only 23% of cash on hand. A ridiculous valuation in anyone’s book.
Or look at Chinese solar manufacturer JinkoSolar (JKS), equally cheap in that it expects to net US$1.84 in 2012 (down from $4.47 in 2011; of course we prefer to use the long-term guidance in our net-present-value calculations, so we effectively discount the current exceptional year), but has extreme value metrics such as price-to-earnings of 0.64, price-to-sales of 0.09, price-to-book of 0.24, and it’s trading at 45% of cash.
So these companies are cheap. Do we think solar is a growth industry? As I wrote in our blog “Green Alpha’s Next Economy:”
“Solar is the best, net most clean, and ultimately cheapest source of power we know of today (and its base source input (sunlight) is free, unlimited, and enormously powerful). It’s been growing as an industry at a 40 percent compound annual growth rate over the last 10 years, it is America’s fastest growing industry at over 100% in 2010, and it shows no signs of slowing.”
Indeed, it’s a rapidly growing space. Solar is actually the fastest growing industry in America, and among the fastest in the world. So with CSIQ and JKS, the Graham-Dodd equation seems well balanced. We’ve found profitable, low-priced companies in a high-growth space that we believe will continue to grow rapidly because continued overreliance on fossil fuels is causing problems.
Increased growth means solar is also rapidly becoming less and less expensive; so much so that a new solar plant will soon be as inexpensive in dollar-per-watt electricity as a new coal plant. In turn, electricity derived from solar is quickly becoming competitively priced, and it does not contribute to climate change. If our investment thesis is, as it must be, concerned with future externalities, these facts are critical. Cheap, effective, non-destructive and trading a low valuations? Sign us up.
Do we know with certainty what will happen in the future? Of course not. But we do know what major problems are emerging, and we know which are likely to have major impacts on the future economy.
Do we know with certitude which technologies and approaches are best for addressing these problems? No, but we have a good idea and we know which ones are working profitably now.
Do we know exactly which companies are best positioned to provide these solutions? We think so, and we can certainly select the most profitable, best managed examples, and endeavor to get them at good valuations. We wouldn’t invest in these companies if we didn’t think they had a better than average chance of providing great opportunities. And in investment management, maximizing your chances of earning a competitive return is what –– and all –– you can do.
Ultimately, we believe the green economy will prevail because we believe people are rational and, as they see changes occurring around them, will make the economic decisions necessary to preserve the best of civilization. Buying the best, most profitable companies already supplying the most effective solutions to our leading concerns could offer the best chance at long term competitive portfolio performance.
Garvin Jabusch is co-founder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEXand the Sierra Club Green Alpha Portfolio. He also authors the blog “Green Alpha’s Next Economy.”
Disclosure: Green Alpha Advisors is long CSIQ and JKS