The market threw some shade at hot solar and renewable energy stock Enphase Energy (ENPH -1.05%) in recent months. The stock fell 16% following its first-quarter 2023 earnings update, perpetuating what is now a negative 27% return so far this year. However, Enphase stock is still up well over 400% over the last three years.  

The company grew its core solar panel inverter business at a rapid pace in the last few years, and also expanded its products and services to include offerings like battery storage. The market wasn't pleased with guidance for later in 2023, though, as Enphase works with consumers who are dealing with higher interest rates, as well as businesses that are growing increasingly cautious about the economy.

Does this post-earnings sell-off create a buy signal? 

What's the big deal with inverters, anyway?

Enphase specializes in microinverters, the devices that convert direct current (DC) from a solar panel to alternating current (AC) used by the energy grid and homes. While solar panels get all the attention as the very visible panels that convert the sun's energy to usable power for homes and for the energy grid, solar inverters are actually the critical device in a solar power system. This means these semiconductor-based inverters have quickly become a key ingredient -- and an expensive one -- when installing a solar system.

This may be surprising, given that there are so many inverter companies out there. With plenty of competition, one might expect inverters to steadily decline in price until there's little profit margin to be had, much like what has occurred with solar panels over the years. This is precisely what has kept me mostly on the sidelines in investing in the inverter market.

The Enphase advantage

But something a bit unexpected has happened with Enphase: Pricing, and resulting profit margins, have risen over time. 

The company's founders developed the microinverter, which places an inverter behind each solar panel and decentralizes a solar array. This can be important, especially for properties with variable sun exposure (trees blocking parts of a roof). It can also help with issues arising from panels with variable power output. By contrast, most systems before the microinverter used a string inverter (like what SolarEdge, another top-performing inverter stock, makes) that combines the power coming from an entire array of solar panels.

But atop its microinverter business, Enphase has also successfully built a software stack that gives added control to owners of a solar energy system. Direct from an app, homeowners and business owners can monitor their solar system's performance, manage power being sold to or taken from the energy grid, and manage network-connected appliances. This has led some in the industry to begin comparing the inverter to the "brain" of a solar energy system, much like a processor coordinates the operations of a personal computer.

It's one of the reasons Enphase's sales have stayed so hot for years now. The trend continued in Q1 2023, with the company reporting year-over-year revenue growth of 65% to $726 million (primarily from the sale of over 4.8 million microinverters, most of them their newest IQ8 microinverter).

Additionally, the company saw rising profit margins, as it gets more operationally efficient with every new incremental sale of a microinverter. Gross profit margin was 45% in Q1, up from 40.1% a year ago, and adjusted earnings per share (EPS) jumped 73% year over year.  

The stock is falling anyway -- time to buy?

With such epic growth numbers, you may wonder why the stock is falling. The issue was with guidance. Management said to expect Q2 2023 revenue to be in a range of $700 million to $740 million. That's essentially flat with Q1 as well as with Q4 2022 (revenue of $725 million). Gross profit margin guidance of 41% to 44% would also be flat with the previous two quarters.

Enphase's revenue outlook does represent an expected growth rate of at least 32%. Nevertheless, Enphase stock is headed into earnings season at a premium valuation of over 80 times trailing-12-month EPS, or over 46 times trailing-12-month free cash flow. Suffice to say, the market was hoping for rosier guidance.  

Nevertheless, if you've been waiting for a pullback in Enphase before buying, this might be your opportunity. Business is still growing, especially in newer markets like Europe and Brazil, as it brings its microinverter processor to new geographies. Battery storage, home charging stations for EVs, and other ancillary equipment are also in the early innings for Enphase. As the company works through some macroeconomic headwinds in its primary market in the U.S., stronger growth could make a comeback later in 2023, especially with funding from the Inflation Reduction Act coming in.

After watching from the sidelines for years, I might put Enphase on my buy list after this quarterly report. If I do buy, I will start very small and build a position gradually over time, assuming the positive story continues. I believe prudence to be wise, given the rich valuation and near-term uncertainty for the company's growth.

For a well-rounded play on renewable energy, my focus also lies on the semiconductor market with names like ON Semiconductor, which makes the power electronics components Enphase and other renewable energy companies need to make microinverters and other equipment.