Fuel cell stocks had a great run in 2020. Plug Power (NASDAQ:PLUG) led the way as its stock surged a whopping 973% during the year. Though it's been around for decades, hydrogen fuel cell technology has seen renewed interest in part due to a push from the European Commission, which envisions 13%-14% of Europe's energy coming from hydrogen by 2050. Considering Europe's progress in using renewable sources -- including solar and wind -- for electricity generation, its vision for hydrogen has some chances of materializing. So, is the enthusiasm behind fuel cell stocks well-founded? Let's discuss what may and may not work for fuel cell stocks in 2021 and beyond.

Factors favoring fuel cells' increased adoption

Hydrogen fuel cells can produce energy without any direct carbon emissions, their only by-product being water. However, nearly 95% of all the hydrogen in the U.S. is currently derived from natural gas, so it's not as clean as it looks. Nonetheless, the objective is to increasingly use renewable sources to produce hydrogen, which essentially makes it a zero-emission source of energy.

A sign for EV and hydrogen (HYD) cars to charge and fuel.

Image source: Getty Images.

Hydrogen fuel cells solve the biggest issue that's restricting the widespread adoption of solar or wind as an energy source -- the ability to store energy for later use. While lithium-ion batteries solve the storage problem, hydrogen fuel cells have some advantages over them. Fuel cells are more compact and can be recharged faster compared to batteries. So, for the same weight, a hydrogen fuel cell-powered vehicle can go longer compared to a battery-powered one. For large vehicles like trucks, this could be a key benefit. Long recharge time and the frequent need to recharge are two key restrictions on the growth of battery-powered electric vehicles.

The transportation segment could therefore be a huge potential market for hydrogen fuel cells. But car manufacturers are divided on what could be a more promising technology for future. Several European car manufacturers have already invested billions of dollars in advancing fuel cells, and could be key potential customers for fuel cell suppliers.

Challenges facing fuel cells

Hydrogen fuel cells have their own challenges, the biggest being cost. Due largely to their production in small numbers, hydrogen fuel cell vehicles tend to be more costly than battery-powered ones. Even outside of the transportation segment, hydrogen fuel cells are not yet economically viable. Moreover, the infrastructure to refuel hydrogen-powered vehicles is not yet in place -- a task that will require substantial time, investment, and government interest. Fuel cell manufacturers may continue to struggle, as they have been for years, until the technology gets a broader adoption.

There is also substantial energy loss associated with the process of producing hydrogen from gas or renewable sources, transporting it for use in refueling, and again converting it into energy for consumption. In comparison, batteries are more energy efficient. Finally, hydrogen fuel cells can be more dangerous due to hydrogen's combustible nature. All in all, there are many significant obstacles on the road to a hydrogen economy.

What it means for fuel cell companies

Despite the potential, it is worth noting that leading fuel cell companies, including Plug Power, FuelCell Energy, Bloom Energy, and Ballard Power Systems have all been generating losses over the past several years. Meanwhile, prices of fuel cell stocks have risen significantly, and they seem to be trading at astronomically high valuations based on traditional valuation measures.

PLUG Net Income (Quarterly) Chart

PLUG Net Income (Quarterly) data by YCharts

Top supplier Plug Power is targeting the European market, including car manufacturers. It could be a significant turning point for Plug Power if one of these manufacturers becomes its pedestal customer. Among top fuel cell companies, Plug Power looks better in terms of revenue growth and strategy.

Although fuel cell technology is promising it faces several practical challenges in its widespread adoption. Even if it becomes popular, it may take years for fuel cell companies to become profitable, if at all. Moreover, there are extremely low barriers to entry, so these companies could face significant competition and thin margins -- even if they manage to generate positive margins. So their sky-high valuations aren't justified.

There are far too many things that need to go in fuel cell companies' favor to make them profitable. If any one of these things doesn't fall into place, the stocks may plunge big time. Fuel cell stock prices have been very volatile historically. In short, despite widespread enthusiasm, fuel cell stocks face significant risks, which might not be worth taking. I would rather watch these stocks from the sidelines in 2021.

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.