The Nasdaq 100 is a commonly quoted index. It represents the 100 largest non-financial stocks on the Nasdaq stock exchange, making it an excellent yardstick for growth stocks.
The Nasdaq 100 has trounced the performance of the S&P 500 so far this year. In fact, over 80 of the Nasdaq 100 stocks have produced a positive year-to-date gain. Enphase Energy (ENPH 3.80%) is not one of those stocks. As of Aug 10, it's down a painful 48% this year, which is bad on its own but even worse, considering this has been a phenomenal year for the Nasdaq 100.
Let's dive into the long-term investment thesis for Enphase to see if it still holds up or if the stock's sell-off was justified.
Image source: Getty Images.
A bit of context
A big reason for a stock's sizable outperformance or underperformance can be something as simple as how that stock fared in the last year or two. Enphase Energy was up 44.8% in 2022 compared to a 33% loss for the Nasdaq 100. If we look at the last three years, Enphase is outperforming the Nasdaq 100 by a wide margin even when factoring in this year's sell-off, which goes to show the extent of the stock's epic run leading up to 2023.
Still, for a stock price to be essentially cut in half in less than a year usually means something is wrong, especially for a company like Enphase that has carved out a leading position in a growing industry.
Enphase's greatest challenges
The biggest risk to Enphase is the commoditization of its products, which would crush margins and potentially break the investment thesis. However, that risk seems overblown.
Enphase has done an excellent job of branding itself as a one-stop shop that provides much more than just microinverters. The Enphase Home Energy System and Commercial Enphase Energy System are integrated solutions. By offering a portfolio of interconnected products instead of a single component, Enphase has more pricing power and can reach a wider range of customers.
Even if Enphase's margins take a hit in the short term, the company's solid business model should outlast the cyclicality of the broader industry. But despite having a diversified product suite, Enphase depends on a strong market for residential and small commercial solar systems.
The current solar industry is in an awkward position. The industry benefits from the long-term tailwinds of government subsidies and the flurry of aggressive emissions reduction and net-zero goals by countries and companies that have taken shape over the last three years. As the industry has matured, the economics of solar have also gotten better due to technological improvements. Enphase has found itself in the coveted sweet spot of providing more value to customers, which has justified price increases and led to margin expansion.
However, the solar market is directly impacted by higher interest rates. Higher interest rates are especially damaging to residential solar, which is the bulk of Enphase's business. On its second-quarter 2023 conference call, Enphase said that the economics of loan financing in key states like Texas, Florida, and Arizona have worsened because of rising rates and lower utility rates.
This is something that is often overlooked when thinking about the challenges of residential solar. To make financial sense, the residential system has to have a reasonable return on investment, which is impacted by interest rates, the rate of electricity customers can get from the grid, and the rate that people can sell electricity back to the grid. Utility-scale solar projects provide environmental benefits while lowering costs for utilities. The more that utilities invest in utility-scale solar, the more competitive their pricing can be, which hurts the residential solar industry.
What Enphase has going for it
Aside from its market position, a big thing Enphase has going for it is its balance sheet. The company has an over $500 million net cash position, which gives it plenty of dry powder to make a cash acquisition or buy back its own stock. The company just announced a $1 billion buyback program. And when analysts pressured management on the Q2 2023 earnings call if buybacks were a good idea in the face of its struggling business, Enphase erased all doubts when it essentially said it has all the cash it needs to invest in growth, run its operations, buy back stock, and make an acquisition.
Perhaps the biggest benefit for Enphase is that the stock has its lowest price-to-earnings (P/E) ratio ever, mostly due to the fact that it hasn't been profitable for that long, and the stock has sold off.
ENPH PS Ratio data by YCharts.
In the above chart, you can see that Enphase currently sports a 35.3 P/E ratio, which some investors would find reasonable for a growth company. It also has a price-to-sales ratio of 7.3, which isn't cheap, but it is far lower than the three-year median of 19.8.
In sum, Enphase stock deserved to fall. The company is guiding for lower revenue in the third quarter of 2023 than it earned in Q3 2022. And even if the long-term investment thesis is bright, Enphase's fundamentals needed to catch up to its valuation.
However, the intense sell-off in Enphase stock essentially fast-tracked a reset in expectations. Instead of needing its fundamentals to catch up to its stock price, the stock price fell to better reflect the fundamentals.
Enphase is still a good long-term holding
No one likes losing money. But the sell-off in Enphase stock was justified, and it is arguably good for anyone considering buying this stock. The stock is now better priced for an ongoing slowdown in Enphase's order volumes. What's more, the stock will start to look cheap if Enphase returns to a fast growth rate.
Buying Enphase stock before its 2023 sell-off was a bet on the company maintaining high gross margins and a breakneck top and bottom-line growth rate. Buying Enphase stock now doesn't depend nearly as much on those assumptions. Rather, it's a bet on the company's ability to return to growth in the future, not maintain that growth now. It's a far more reasonable expectation and gives Enphase the room it needs to surprise to the upside instead of being priced to perfection and leaving room for the stock to fall.
