Diversification, a core aspect of most modern-day portfolios, is a strategy many advisers advocate for reducing the overall risk of an investor's holdings. The strategy is used to safeguard a portfolio so that problems at one company cannot single-handedly sink it. Investors who neglect to diversify are more prone to single negative events than those who adhere to this basic strategy.
With the BP (NYSE:BP) oil spill into its third month now, many investors, including institutional investors, were given a very expensive lesson in diversification. Numerous pension funds, especially the ones in the U.K. that had invested a large portion of their portfolios in BP stock, found themselves in a very bad position. According to The Times in London, approximately 17% of all dividends paid to U.K. pension funds came from BP. This means that 17% of pensioners' dividend income was eliminated when BP cut its dividend, on top of witnessing a 50% drop in BP's stock year to date.
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So, in the name of diversification, let's take a look at alternative energy investments to help balance your portfolio.
Based out of Reno, Nev., Ormat Technologies (NYSE:ORA) is one of the more profitable alternative energy companies available. The company designs, builds and operates geothermal systems and recovered energy-based power plants worldwide. Ormat currently trades at a valuation premium relative to its peers, with a P/E multiple of 25 compared to 12 for the industry. However, the expected growth for Ormat is high, which leads to a potentially attractive PEG ratio of slightly less than 1. (For related reading, check out Clean Or Green Technology Investing.)
A recent report by the Massachusetts Institute of Technology (MIT) predicts that the U.S. will double its consumption of natural gas within a few decades. The report expects the market share for natural gas to increase from its current level of 20% to 40%, thanks to natural gas's cleaner burning properties and abundance of supply.
EnCana (NYSE:ECA), a pure play natural gas company, will likely benefit from the increased demand in natural gas. The company trades with a trailing P/E ratio of 10.4 compared to an industry average of 12 and the S&P/TSX Composite average of 15.7. Despite its low valuation, most analysts appear bearish on EnCana right now, which is likely due to the declining trend in natural gas prices and the existing glut of supply. According to Reuters, 13 analysts have a "hold" rating on the stock, while nine others have either a "buy" or "outperform" rating. (To learn about investing in natural gas, read Become An Oil And Gas Futures Detective.)
Uranium is the one alternative energy that, in my opinion, has the greatest potential to fill the world's future energy needs. Uranium is a phenomenally powerful fuel source. A handful of uranium has the potential to generate more energy than over 100 tons of coal. In addition, many anticipate a supply shortage of uranium within the next five years. According to the Global Top 10 Uranium Mining Companies Benchmarking Analysis, uranium reserves fell from 697,177 tU in 2008 to 669,270 tU in 2009. Reserves are not replenishing as fast as demand is growing, which could lead to a steady rise in uranium spot prices over the next few years.
Canada-based Cameco (NYSE:CCJ, TSE:CCO) is the top company when it comes to uranium mining with respect to size. The company owns assets in the U.S., Canada, Australia and Kazakhstan and trades with a P/E multiple of 11.5 compared to 18.7 for the industry. Similar to EnCana, analysts are fairly bearish on Cameco, with 12 rating the stock as a "hold" and another seven rating it either a "buy" or "outperform".
Look to diversify some of your energy stocks into alternative energy stocks. Some of the alternative energy sectors are currently out of favor with analysts, and those may very well be the areas that are the best to look into. (For more stock analysis, take a look at Making Money With Regional Banks.)
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