Shares of solar energy microinverter maker Enphase Energy (ENPH -3.41%) tumbled more than 10% in early trading Thursday before climbing back to about a 6.6% loss as of 1:45 p.m. EDT. The stock's slide followed a report Wednesday that investor research firm Institutional Shareholder Services EVA had downgraded Enphase rival SolarEdge Technologies (SEDG -1.46%) from buy to overweight.
Does selling one stock because another got downgraded make sense, though?
Perhaps not. True, "solar stocks" sometimes trade in tandem, for example, when tariffs are raised or lowered on imported solar panels. But tariffs are actual news, as opposed to downgrades, which are matters of one person's opinion. The downgrade of one stock for any reason (and note that we don't even know the precise reason for ISS EVA's downgrade in this case) doesn't necessarily mean bad things for another solar stock. To the contrary: When the two companies are rivals, bad news for one might mean good things for the other.
And lacking any other news affecting SolarEdge or Enphase or the solar industry as a whole today, I don't see SolarEdge's downgrade -- especially one as minor as a move from buy to overweight -- as being a reason to sell Enphase, too.
That's not to say there are no other reasons to sell Enphase, however. First and foremost, to my mind, is the stock's valuation of 35 times earnings.
Thirty-five times earnings seems a bit pricey to me, given that Enphase's earnings this year are expected to go down, not up, and that analysts predict (according to data from S&P Global Market Intelligence) that even when earnings do start growing again, next year, they still won't even equal what Enphase earned in 2019.
Moreover, free cash flow at Enphase ($144 million over the last 12 months) is already weaker than reported net income ($227 million). With Enphase generating only about $0.63 in real cash profit for every $1 in earnings it claims, the stock's share price works out to more than 55 times free cash flow -- such that Enphase is arguably even more expensive than it looks on the surface.
If you're looking for a reason to sell Enphase, I think overvaluation is a pretty good one.