The Stock That Had Me Convinced I Was Stupid (Part 2)

Last update on June 17, 2013.

In my last post, I began to talk about First Solar, which is a company I eventually invested in. I explained why it was the darling of the renewable energy sector, and why it fell from grace.

In this podcast, I explain why I jumped into the stock, and what happened.

 

 

Transcript:

Hello, and welcome to MoneyGeek's podcast. My name is Jin, and in this episode, I'll continue from my last episode and talk about my experience in investing in First Solar.

In the last episode, I explained why investors dumped First Solar. To recap, the three reasons were cuts in European subisides on solar panels, aggressive price competition from Chinese solar companies, and a plunge in natural gas prices which made natural gas power plans more attractive.

In fact, investors were so gloomy about First Solar's future, that nearly 32 million of First Solar's shares were shorted on June 2012. It was one of the most shorted companies at the time.

For those of you who don't know, 'shorting', is when an investor bets against a company. They typically do this by borrowing shares from someone else, and selling it. As a result, they have cash, but they owe shares. They're hoping that share prices will decline, at which point they'll buy the shares, and then return them to whoever they borrowed from. Perhaps I'll explain shorting in another blog post. But in summary, these so-called investors saw nothing but trouble for the company.

Here's something you should understand. This is the perfect condition for investing in a company.

It's almost never a good idea to invest in a company, if everyone is postive about it. Why? Because that's when a stock is likely to be overvalued.

Take Apple, for instance. Everyone was super positive on the stock about a year ago, as Apple stock was reaching new highs at $600. The reason was simple. Everyone was buying the iPhone. Everyone was buying Macs. They've had huge growth, and high margins. What's not to like?

But then, what happened to them? Apple's stock fell from a peak of over $700 a share, to less than $450 where it sits today. Many people lost money. In other words, it was a terrible to invest, because everyone was positive on the stock.

Conversely, the best time to invest is when everyone is negative on a stock, because that's when a stock is likely to be undervalued. That's why the spring of 2012 was a great time to consider buying First Solar.

But at the same time, you do need a reason to disagree with all the negativity, and that reason needs to be a rational one. Otherwise, it's nothing more than a gamble that the crowd has got it wrong.

With First Solar, I found a reason to disagree.

On December 2011, a company called MidAmerican Energy decided to buy a solar power plant from First Solar. MidAmerican is a division of Berkshire Hathaway, which is Warren Buffett's company. Just to clarify, this doesn't mean that Buffett bought First Solar stock. Instead, it meant that Buffett was First Solar's customer.

This was no small sale. It's estimated that MidAmerican paid between $1.65 billion and $1.95 billion for the plant. That's a hefty chunk, considering First Solar only recorded $2.8 billion in sales for the whole of 2011.

That got me thinking. Obviously, Buffett is not stupid. He would not buy solar plants if it didn't make economic sense for him. To me, this meant that solar plants must be attractive to other utility companies as well. In other words, First Solar will still have customers in the U.S..

What's more, I think the gloom and doom around solar stocks were great for First Solar in the long run. That's because for First Solar, there's a bigger threat than the triple threat I mentioned in the last episode, and that's the threat of new technology.

Every year, I read about how researchers from MIT or some other university, invented new solar cells that have much greater promise than the ones currently produced. I don't know how commercially viable they are, but I can imagine that some of them may hold great commercial promise as well.

If theoretically, we find that one such new type of solar cells are vastly superior to First Solar's cells commercially, then First Solar is toast. This is not something First Solar can recover from, unlike the threats facing the company in 2012.

During times when solar stock prices are high, investors fund many new solar companies. Because they're feeling very positive about solar, they want a piece of the action. But when solar stock prices are low, no one funds new solar companies. This meant that I didn't have to fear too much from some breakthrough techonology bringing First Solar down.

With these in mind, I imagined what First Solar would look like in 5 years if it survived. Solar panels benefited from their own Moore's law, which basically meant that solar panels became cheaper, all the while becoming more efficient. Many experts were predicting that Solar will become a relatively cheap source of energy in 5 years.

Imagine that - a world in which Solar Power is cheaper than Coal. In such a world, no utility company will build new coal plants - they'll build solar instead.

My thought process moved on to imagining what First Solar would be worth in such a world. I took a conservative projection, and thought that it might make as much profit as it made in 2010. In other words, a profit of $600 million or so. I then imagined that it might fetch 15 price-to-earnings ratio. Between these numbers, I imagined First Solar might be worth $9 billion in 5 years. At the time, the company was worth around $2.5 billion.

What's the compound rate of growth per year for something goes from $2.5 billion to $9 billion in 5 years? The answer: about 30%/year.

In other words, if I was right, I will get a rate of return of 30%/year on my investment in First Solar. As you can imagine, this was an acceptable rate of return for me. So on March 2012, I took the dive. I bought 200 shares of First Solar at around $26 per share.

That's all I have for this episode. In the next episode, I'll talk about what happened my shares. Thanks for listening, and have a great day.

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