The Perils of Momentum Investing: 3 Profitable Exceptions

In a recent article “3 High Risk Trades to Avoid,” we warned investors about the perils of momentum investing, a strategy based on hype about an investment theme, a new product or a new industry that captures and captivates the investor mind-- at times when money is cheap. We did remind investors that the momentum crowd hyped with the potential of the telecommunications and networking industry in the late 1990s, falling in love with stocks like Cisco Systems (NASDAQ:CSCO), Ciena Corporation (NASDAQ:CIEN), JDS Uniphase (JDSU), and Ariba Networks (NASDAQ:ARBA), suffered hefty losses once the hype faded.

Here we take a closer look at the fate of another momentum crowd hyped by the potential of sustainability industry in the early 2000, buying up the stock of alternative energy companies.

For years sustainability investing was confined to the venture capitalist community only that relied heavily on government support to make money. In the last decade, sustainability investing extended to mainstream investors, as scores of start-ups in solar energy, wind energy, and geothermal energy went public: First Solar (NASDAQ:FSLR), for instance, manufactures and sells photovoltaic systems and solar modules; SunPower Corporation (SPWRA) works together with utilities to develop solar power plants; and Hoku Scientific (HOKU) and MEMC Corporation (WFR) are silicon suppliers. Beacon Power Corporation makes flywheel energy storage systems, while Western Wind Corporation (OTC:WNDEF) operates wind farms. US Geothermal Inc. (NYSEMKT:HTM) and Ormat Technologies (NYSE:ORA) build geothermal plants.

In the beginning of the decade, most of these stocks popped, as momentum investors believed that the prices of traditional energy, like crude oil, will reach for the moon and solar panels and windmills will grow like grass in early spring chased after them. By the end of the decade, the same stocks crashed, as neither belief proved to be truth. In fact, with the exception of First Solar, West Wind Energy and Ormat Technologies, every alternative energy stock listed in the table below suffered hefty losses.

First Solar commands a P/E ratio, and a profit margin of 23.72. A pioneer in the thin-film technology that uses no silicon, the company improved the efficiency of solar panels, while sheltering itself from silicon shortages that disrupt traditional solar manufacturing. First Solar further enjoyed the "first-mover," which gave them an edge over followers like Ascent Technologies (ASTI).

Ormat Technologies has P/E of 37.75, and a profit margin of 6.82; The company also enjoys the "first-mover advantage," but in two other segments of "green industry," geothermal energy, and recovered power generation, winning long-term contracts in US, Canada, Spain, and India.

Western Wind Energy a forward P/E of 29.61 and a profit margin of 96.85. The company has been greatly benefited by generous incentives by the state of California, where most of its solar and wind farms are located.

The bottom line: When momentum fades only profitable companies will survive and thrive, rewarding their stockholders with healthy capital gains.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.