Warren Buffett is famous for saying, "In the short run, the market is a voting machine. In the long run, it's a weighing machine." What the Oracle of Omaha meant is in the short term, stock prices are largely a popularity contest ruled by the latest hype and speculation. However, in the long term a company's shares will trade based on earnings it can deliver to shareholders. 

In the last year, few industries have been victims of rampant hype-fueled speculation more than fuel cell stocks -- Plug Power (PLUG -6.95%), Ballard Power Systems (BLDP -2.68%), and FuelCell Energy (FCEL -6.06%). 

PLUG Chart

PLUG data by YCharts

The share spike was triggered by Plug's announcement of a major contract with Wal-Mart (for 1,738 fork-lift power units over two years) and a contract with FedEx (for a $3 million DOE-sponsored test of fuel cell range extenders in 20 FedEx trucks).

With the recent sharp pullback in price for all three stocks, investors might be asking if this represents a buying opportunity for a promising growth industry. As this article will explain, the potential for fuel cells is much less than the recent share price explosions would indicate, and there are several fundamental flaws with how all three companies are run -- flaws that are likely to either result in long-term underperformance or outright losses. 

What's the deal with fuel cell companies?
The major fuel cell companies -- Plug Power, Ballard Power Systems, and FuelCell Energy -- operate in three separate niches.

Plug Power specializes in cargo movers, specifically fork-lifts and delivery truck systems, a potential $4 billion market. Ballard Power Systems specializes in remote power generation and gas-fed fuel cell back-up systems for things like telecommunication systems, a $4.5 billion market. FuelCell Energy operates in the larger, $10 billion-$12 billion, heat and power generation industry (and it sells larger systems to utilities).

Interestingly, until Plug Power's recent $4 million acquisition of ReliOn Inc (makers of power backup systems) the company didn't make fuel cells, but rather the components to incorporate them into fork-lift power systems. Plug sourced its fuel cells from Ballard Power Systems, which provided 10.6% of Ballard's 2013 sales.

Two reasons against investing in fuel cells
There are two primary reasons against investing in Plug Power, Ballard Power Systems, and FuelCell Energy: market uncompetitiveness and a fundamental problem with the companies themselves.

Specifically, I am referring to the fact that currently the cost of using fuel cells as either energy generators or backups is 20%-30% more expensive on a price/watt installed basis than natural gas or certain forms of renewable energy.

This will greatly hinder the adoption of fuel cells in general and limit the size of the potential markets of these three companies. Even if these basic economic realities change and fuel cells become cost-competitive, there are two fundamental flaws with how these companies operate that are likely to make them bad long-term investments -- even if the companies themselves prosper. 

PLUG Revenue (Annual) Chart

PLUG Revenue (Annual) data by YCharts

PLUG Chart

PLUG data by YCharts

What these graphs indicate is a fundamental problem for these companies both in terms of profitability and share dilution.

Ballard Power Systems and FuelCell Energy are better off than Plug Power with positive gross margins. However, Plug's margins are catastrophically bad and look to be getting worse, despite management's insistence that EBITDA break-even will occur by Q2 or Q3 of 2014. 

In fact, I feel I must call out Plug Power's management for some of the most misleading guidance I've ever seen from any company. For example:

  • "Plug Power will achieve a gross margin percentage in the mid-teens." [in 2009]
  • "We do expect that both a ramp in shipment volumes and an increase in share of shipments from new product platforms over the remaining quarters of 2012 will boost gross margins into positive territory."
  • "Plug Power will generate between mid $40 million and low $50 million in revenue." [in 2009]
  • "We're also on track to meet our target of shipping $40 million of revenue in 2012."
In fact, Plug's 12-month revenues have never exceeded $33 million, its gross margins have never been better than -25%, and its quarterly EBITDA is moving exponentially in the wrong direction. 
 
But perhaps the biggest reason investors should avoid Plug Power, Ballard Power Systems, and FuelCell Energy is because all three companies are guilty of heavy shareholder dilution, though Plug Power with its 11-fold increase in share count in just four years (82% CAGR growth in shares) is by far the worst. However, even Ballard Power Systems (12% annual dilution rate) and FuelCell Energy (32% annual dilution rate) print shares at a pace that makes growth in earnings per share -- the sole long-term determiner of non-dividend paying share prices -- very difficult. 
 
Foolish bottom line 
Fuel cells are currently not economical, and even if that changes and they develop widespread adoption, it's likely that companies such as Plug Power, Ballard Power Systems, and FuelCell Energy would continue to struggle with profitability and share dilution that would make market outperformance difficult to come by. Until these fundamental problems with both the fuel cell industry and these companies in particular are fixed, I advise against owning all three.