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The Best Solar Stocks for 2016

By Travis Hoium, Tyler Crowe, and Jason Hall - Jan 31, 2016 at 9:00AM

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Who could take advantage of solar energy's massive potential?

Image source: SunPower. 

Solar energy is the fastest-growing segment of the energy market, with the potential to upend electricity generation around the world. For investors, that presents an opportunity in the $2 trillion electricity market worldwide. 

But solar stocks haven't been very kind to investors over the past decade as companies rise and fall. With the industry reaching a new level of maturity, here are three stocks set to succeed in 2016. 

SunPower's X-Series panel is the most efficient mass produced solar panel on the market. Image source: SunPower.

Travis Hoium: 2015 exposed a lot of flaws in solar companies, which surprised a lot of investors. We found out SunEdison was overleveraged and built on a house of cards that required yieldcos with low dividend yields to generate value. Investors started to question the assumptions in retained value that drove stocks like SolarCity, Vivint Solar, and Sunrun into the public markets. A few things that weren't questioned in 2015 were that SunPower (SPWR -1.85%) continued to make the most efficient solar panel available on the market today and continues to report profitable operations, something most solar companies can't say.

While many competitors went public and began to wow investors with growth targets, SunPower stayed the course of creating a great product and not expanding so quickly that it outgrew its reach. That strategy has now paid off, with an internationally diverse group of end markets that include everything from small handheld devices to the largest solar plants in the world. It also means that now that the global solar market has reached grid parity, and projects are being won based on economics, SunPower is in a position of financial strength and can turn on the growth engine.

Over the next three years, SunPower expects to triple production, adding a lower-cost, lower-efficiency product called P-Series for non-OECD countries as well as expanding high-efficiency production. With the extension of the investment tax credit in the U.S., I think there's even greater opportunity for expansion if the company chooses, building projects that could be sold to third parties, held on the balance sheet, or sold to its yieldco, 8point3 Energy Partners (CAFD).

Shares of SunPower trade at just 14 times forward earnings, which doesn't take into account the long-term value of projects being built on the balance sheet and being held by 8point3 Energy Partners. When you combine that valuation with the company's growth prospects and strong strategic position, I think it's the best solar stock for 2016 -- and many years to come. 

Tyler CroweOne thing I'm looking for more and more in my investments is cold, hard cash -- or at least the ability to generate gobs of it. Not only do I want companies that can plow that cash pile back into the business, but I want them to pay me some of that cash as well in the form of a dividend. In the solar business, there aren't many companies at the point in their development cycle where paying a dividend is their best allocation of capital. That's OK -- I can wait until they're ready before I start to gobble up shares. For 2016, though, I'm have my sights on a small segment of the solar industry that's paying dividends: yieldcos. More specifically, I have my eyes on 8point3 Energy Energy Partners. 

Rather than owning a company that manufactures solar cells or develops projects for sale, 8point3 is in the business of owning competed solar projects that are generating cash now. Its current portfolio of utility projects looks strong, and it's co-owned with utility companies that have very low counterparty credit risk, ensuring that 8point3 is at a lower risk of seeing a customer default on a contract payment.

Image source: 8point3 Energy Partners investor presentation.

I can certainly understand why some investors might be gun-shy about 8point3 Energy Partners if they're looking for stable income. It doesn't have a long track record of payments that income investors like to see, and it takes a couple extra hours to understand the income statement. One thing that does work in its favor, though, is that its sponsors -- Sunpower and First Solar -- are managed pretty conservatively, and it's not a stretch to assume that same conservatism will be applied to 8point3 Energy Partners as well. 

With a dividend yield of 5.5% today, and what looks to be a long road of payments ahead of it, 8point3 looks to be one of the better ways to invest in solar and get paid now. 

Jason HallI admit this could be one of the riskier investments in solar, but there's also huge upside in both the near term and long term. 

SolarCity (SCTY.DL) is the largest residential solar installer, and its business is clearly hitched to this wagon. The upside is massive growth potential, with residential solar currently making up less than 1% of U.S. power production, leaving plenty of room for growth. 

The biggest risk? Regulatory changes, as we've recently seen in Nevada. That state's utility authority essentially killed residential solar overnight by eliminating net metering, which allows residential solar users to piggyback on the grid, trading their excess solar production for credits that cover evening power usage. In the wake of this, SolarCity closed its Nevada operations and has been waging a public campaign to get net metering reinstated. 

Arizona could be the next to change policies this summer. However, that state has thousands of solar industry jobs and a much larger base of installed residential solar, so it's more likely that regulations will either remain unchanged or be a compromise between utilities and residential solar. 

That, in short, is the not-inconsiderable risk. The upside? SolarCity is on track to grow its business by half this year, and it has taken steps to cut marketing and sales costs in a move aimed at reaching cash flow positive by year end. It's also on track to manufacture its own high-efficiency panels, lowering costs and gaining better supply chain control. 

Add in how beaten-down the stock is over the past year, and if you're willing to take on the higher risks, SolarCity should be on your list for 2016. 

Solar energy is a massive opportunity
No matter how you play it, solar energy is a massive opportunity. SunPower, 8point3 Energy Partners, and SolarCity are just three of the companies with incredible potential for growth as the industry grows. 

Jason Hall owns shares of SolarCity. Travis Hoium owns shares of 8point3 Energy Partners LP and SunPower. Tyler Crowe owns shares of SolarCity. The Motley Fool owns shares of and recommends SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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$25.39 (-1.85%) $0.48
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