Solar stocks were scorching hot in 2020. The Invesco Solar ETF, an exchange-traded fund (ETF) with 30 solar-focused stocks, soared by more than 230% in 2020. However, as impressive as that was, SolarEdge Technologies' (NASDAQ:SEDG) stock was even hotter in 2020, as it skyrocketed more than 240%.  

That big run probably has investors wondering whether the stock will cool off in 2021. Here's a look at the case for and against buying SolarEdge Technologies stock right now.

Solar panel inverters.

Image source: Getty Images.

The case for buying SolarEdge

The solar industry has reached an inflection point. It's cheaper to build new solar capacity in many regions than a new combined-cycle natural gas power plant. Meanwhile, solar energy is on track to become the lowest cost form of bulk power in the coming years, and that's with the added cost of energy storage. The industry is thus on pace to accelerate over the next decade. Current forecasts have the solar industry adding an average of 10 gigawatts (GW) of new capacity per year from 2019 through 2022, with that average jumping to 18-20 GW in the 2023 to 2030 timeframe, or a more than 15% average annual growth rate.

That outlook bodes well for SolarEdge. The company, which makes an optimized inverter to maximize the power generated and reduce the cost of energy produced by solar panels, should benefit as the solar industry installs an increasing number of new solar panels each year. On top of that, the company is investing in other emerging technologies like energy storage, electric vehicle charging, and grid services solutions, which should also benefit from the accelerated shift toward cleaner energy. For example, the company noted in its third-quarter earnings report that its e-Mobility team is about to deliver its first significant batch of full powertrain solutions for electric vehicles to a customer in the fourth quarter. 

Finally, SolarEdge has a strong balance sheet to capture future growth opportunities. The company ended the third quarter with $553.8 million of net cash, and its business continues to generate significant cash flow each quarter.

The case against buying SolarEdge

While SolarEdge Technologies has a bright future, the market baked much of that upside into the stock this year. While shares more than tripled this year, revenue was only up 9.3% through the third quarter while diluted net earnings per share were up 12.2%. Thus, the stock has gotten significantly more expensive:

SEDG PE Ratio Chart

SEDG PE Ratio data by YCharts

On one hand, the global pandemic affected its valuation as it affected the U.S. solar market in 2020. SolarEdge's total revenue declined 18% in the third quarter compared with the prior-year period, while earnings per share flatlined. Thus, if the pandemic didn't affect demand, the company's profits this year would have probably been higher, which means its valuation wouldn't have reached such heights.  

However, even a look at the company's projected earnings still has it trading at a nose-bleed valuation of 81 times forward earnings per share and 62 times its enterprise value to EBTIDA. Because of that premium price, shares might stagnate until it grows into its valuation. Meanwhile, it's likely that if the market sells off, SolarEdge's stock might take a nasty fall as traders race to lock in profits.

Aside from valuation, another potential concern is that SolarEdge needs to continue investing heavily to stay ahead of its competitors and maintain its market lead. If its rivals develop a better product, SolarEdge could lose its edge, which could cause its stock to cool off quickly.

Solar has a bright future

There's no doubt that SolarEdge Technologies' massive run-up in 2020 has it trading at a premium price. But that means it could also cool off in the near term.

However, given the growth ahead for solar, the company could quickly grow into its valuation as it expands its margins and earnings. So it still seems worth buying for investors who plan to hold for what appears to be a golden decade ahead for solar energy.  

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.