Challenges Faced When Analyzing Green Chip Stocks

By Ryan C. Fuhrmann AAA

The term “blue chip” refers to a stock where the underlying company is very large and considered an industry bellwether. A blue chip often has national and even international renown, a well-established business or brand and a sound financial position. Blue chips generally sell high-quality, widely accepted and available products and services. Their business models have also stood the test of time over many decades and business cycles.

To play off the above well-known company designation, a "green chip" stock is one whose underlying company is a well-known operator in an environmentally-friendly industry or pursues a product or service that is seen as benefiting, or at least inflicting a minimal level of harm, to the environment. It is important to note that a green chip stock is unlikely to have the same market cap as a blue chip stock and may not have operated for decades given the newness of many green technologies. But the term does indicate a current leader in the space, which may or may not persist given the rapid change occurring in green technologies.

Factors Unique to Analyzing Green Chip Stocks

The process of analyzing green chip stocks differs rather significantly from blue chip stocks. Overall, the analysis more closely resembles that of getting a handle on fast-moving technologies and industries, such as social media or internet-based firms. Many green technologies, including alternative and renewable energy, are still relatively new and require a mindset closer to investing in start-up firms utilizing venture capital techniques.

With this mindset, understanding a firm’s business plan should provide an understanding of how it plans to grow and succeed in what is likely to be a newer industry. A solid plan will cover a description of the business, including its operations, financials and marketing plan. The most important section pertaining to green chip stocks will be the industry analysis, including a detailed description of the industry, other competitors and the industry's growth profile. For a younger industry, such as solar energy and fuel cells, it is extremely useful to try and identify the technologies that will develop the scale to bring costs down and increase production for entry into the mass market. This will help define whether it will turn into a green chip investment.

The Paradox of Green Investing

A 2011 Economist article, "Betting On Green," written toward the end of the credit crisis detailed that green investing suffered during the downturn. It noted that many environmentally-friendly industries continued to be driven by policy, not market dynamics, meaning many received subsidies and had not yet achieved the success to compete on their own and generate profits for shareholders. This is one of the paradoxes of green investing and the clearest indicator of how green chip stocks differ from blue chips. Green companies may not be profitable without government subsidies or tax incentives. This provides a dilemma for investors who require cash flows or steady profit trends.

A Green Financial Analysis

If green investing starts through policy drivers created by governments, then social metrics such as reduced carbon emissions, lower poverty levels or increased air and water quality will help determine if a technology is on track and on its way to turning into a profitable investment. The Federal Reserve Bank of San Francisco study on social metrics in investing stated that it is currently difficult to identify many firms that both increase social good and line investor pockets with steady and ample cash flow. It recommends that entrepreneurs help younger green firms turn technologies with positive environmental returns into those that generate favorable investment metrics, such as steady sales growth, growing popularity and lots of eventual free cash flow.

Success could also mean an acquisition by a larger firm that could help it further scale production for the benefit of society and shareholders. One of the best fundamental metrics to use in green investing is to determine whether the company founders and owners understand financial modeling and how to use it for business planning and analysis. Those that capture the best of socially responsible investing and market dynamics stand the best chances of turning their business into a bona fide green chip investment.

Screen for Green Firms and Find Safer Green Chips

The best way to screen for green stocks and uncover some profitable green chips is to get familiar with all the green industries and narrow the search to individual firms. A great place to start is to look at mutual funds and ETFs that hold baskets of green stocks. Examples include the Market Vectors Glb Alternative Energy ETF (NYSE:GEX) that holds about 30 leading green chips. Firms such as Domini specialize in social investments, many of which fall under the green category. Finally, the RENIXX Renewable Energy Industrial Index contains 30 of the largest renewable energy firms throughout the world that currently qualify as green chips.

The Bottom Line

One important green investor in India lamented that the pace of environmentally-friendly development is too slow to bring the needed benefits to the billions of individuals living in emerging markets such as India and China. The world needs thousands more green chip companies to bring social benefits such as cheaper and cleaner energies, affordable and safe transportation, and increased health and longevity. Green investing helps provide the capital to scale such technologies, and learning to analyze green chip stocks could end up being profitable for both customers and shareholders. The fact that a green chip is not yet a blue chip should not alarm investors, but they need to be aware of the differences and challenges that can arise from assuming these are durable companies with sustainable competitive advantages.

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