Enphase Energy (ENPH 0.47%) stock hit a new two-year low on Aug. 7 and is now down over 58% from its 52-week high set in December 2022. The microinverter solar energy technology company was a Wall Street darling. But slowing growth and an overall sluggish period for the solar energy industry have cast a dark cloud over Enphase Energy stock.
The sell-off in Enphase Energy may come as a surprise to investors, given that the company just posted all-time high net income. But Enphase's price action is a painful reminder of a timeless investing lesson -- that a company's results should be judged mainly within the context of expectations and valuation. Let's dive into how this lesson applies to Enphase and how it can help you become a better investor for years to come.
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Blowout results
Five years ago, Enphase was unprofitable, generating less than $100 million in quarterly revenue. It featured a gross margin of roughly 30%.
In second-quarter 2023, Enphase generated over $710 million in revenue, more than an 800% increase compared to five years ago. It also booked $157.2 million in net income.
To put that figure into perspective, consider that in second-quarter 2018 five years ago, Enphase recorded negative net income and booked just $75.9 million in revenue. Doubling revenue in a five-year period would be impressive. But turning an unprofitable business profitable to the point where today's net income is double sales from five years ago is nothing short of a blistering growth rate.
To top it all off, Enphase had a gross margin of 45.5%. This is unbelievably impressive for a company that mostly sells physical products like microinverters, solar AC batteries, internet gateways, monitoring hardware and systems controllers, and electric vehicle chargers. For comparison, Apple (NASDAQ: AAPL), which also mostly sells physical products and is known for having high gross margins, had a 44.5% gross margin in its most recent quarter.
Suffice it to say, Enphase as a business is doing incredibly well, at least right now.
Weak guidance
The issue isn't where Enphase is today, but where it is going. The company's third-quarter guidance calls for $550 million to $600 million in revenue and a GAAP gross margin of $41% to 44%. For context, Enphase generated $634.7 million in Q3 2022 revenue and had a GAAP gross margin of 42.2%. Enphase's growth isn't just slowing, it's actually negative.
Q3 2022 was arguably the best quarter in Enphase's history. And the report came right after the landmark Inflation Reduction Act (IRA) was passed in August 2022. The IRA provides sizable tax credits for renewable energy projects, power producers, and domestic manufacturing of products related to renewable energy. The IRA, combined with the excellent results from Q3 2022, propelled the stock to an all-time high in December of last year. Q3 2022 represented a staggering 81% increase in revenue compared to Q3 2021. The company also booked $114.8 million in net income, compared to just $21.8 million in Q3 2021.
Enphase stock was riding high. But to support the sky-high valuation, the company would have to post quarter after quarter of blowout results.
Investing is all about telling a story
Financial models are centered around hard data. But when we zoom out and think about multi-year or even multi-decade investing theses, they are really about stories supported by the numbers, not the other way around.
Going back to Apple as an example, this company changed the smartphone market forever. But the reason the company has delivered staggering returns since launching the first iPhone in 2007 is its ability to build out a product and services ecosystem that benefits from so many powerful trends. The vast majority of these trends, like mobile apps, mobile payments, music, streaming, and more, revolve around the iPhone and boost its value to consumers.
Enphase's story centers around a growing residential solar market, and, to a lesser extent, small commercial customers. The company depends on not just the growing adoption of solar, but also on the affordability of solar systems. The most expensive component of these systems is the panels, which Enphase doesn't make. Also affecting Enphase are rising interest rates that make residential solar projects less affordable. The cost of selling electricity back to the grid is also a factor. Most important is the performance of Enphase's technology relative to the competition, so that it can charge a premium price.
Enphase's story is being tested for factors mostly outside its control. Supply chain issues challenged the solar industry in 2021 and 2022. Now, the big problem is interest rates, which are weakening consumer demand. When demand falls, companies try to lower prices. And if the whole solar industry is lowering prices, Enphase is pressured to follow suit, which affects its high-margin competitive advantage.
Learning a lifelong lesson the hard way
Enphase stock had an incredible run between 2020 and the end of 2022, a run that put immense pressure on Enphase the company to put up quarter after quarter of jaw-dropping results. The expectations proved unrealistic, as Enphase has entered a difficult period in lockstep with a challenging time for the whole solar industry.
Enphase is still putting up excellent results. But the numbers simply aren't good enough compared to its past performance and the growth rate that Wall Street grew accustomed to.
The good news is that the lower Enphase stock goes, the more its valuation will make sense, and the easier it will be for the company to exceed expectations.
The lesson here isn't that Enphase is a bad company. It's that companies are prone to market cycles. And if the stock's valuation is priced to perfection and leaves no room for the unexpected, it sets the stage for a massive sell-off.
