Headwinds have beaten down stocks in the solar space. Solar ETFs Market Vectors Solar Energy (NYSE:KWT) and Guggenheim/Mac Global Solar Energy Index (NYSE:TAN) are down 9.5% and 7.4%, respectively. Meanwhile, the S&P 500 has rallied nearly 5%. Investors may be able to catch a strong solar wind with several sun stocks with valuations now extremely cheap.

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Sun Stock Sell-off
Solar companies design, supply, manufacture and sell devices (i.e. solar panels) that convert sunlight into electricity via the photovoltaic effect and heat engines. Companies based in the United States, China, Germany and Japan are the leading producers of solar panels used to harvest sun energy.

Until recently, the solar group has been under pressure from several elements, leading to a sustained cooldown in the solar space. The chief limiting factor working against solar is that sunlight is needed for solar panels to generate electricity. This means sunlight is an intermittent source of energy; solar panels can't generate electricity at night or under dense cloud cover. In addition, the solar industry is not autonomous yet, necessitating subsidies to compete as a cost-effective energy source. Cutbacks to feed-in tariffs across Europe have priced down solar shares dramatically. These fundamental problems, coupled with falling solar panel prices squeezing margins, have led to a sustained retracement. Take a look at a few solar stocks getting crushed this year:

  • LDK Solar (NYSE:LDK) down 34%
  • Canadian Solar (Nasdaq:CSIQ) down 18%
  • JA Solar Holdings (Nasdaq:JASO) down 32%
  • ReneSola (NYSE:SOL) down 45%

Even high petroleum prices (a driver for green energy stocks) and an added solar safety premium following the Fukushima meltdown haven't stopped short sellers.

Sunny Valuations
It's time to go bottom fishing. The dramatic sell-off has made solar stocks extremely cheap, as there remains a great underlying investment story. Solar is an abundant, safe source of energy. Even though the industry is still about a year away from parity against other alternative energy sources, new technologies keep pushing that cost lower. Polysilicon and wafer costs have come down recently.

As solar increasingly becomes more cost competitive, integrated suppliers that have seen their valuation adjust become ever more attractive. One such company is China-based Yingli Green Energy (NYSE:YGE), down 20% year-to-date. Amtech Systems (Nasdaq:ASYS), which makes furnace equipment to produce solar cells, is another interesting name. MEMC Electronic Materials (NYSE:WFR), down 30% year-to-date, is a high-beta play on its new solar wafer technology.

A more conservative way to add solar to your portfolio is Tempe, Arizona-based First Solar (Nasdaq:FSLR). Shares of First Solar have not corrected like other names in the group. First Solar's price stabilization reflects a strong balance sheet and market leadership. Last month, the solar-panel producer scored the largest federal investment into a solar company from the Department of Energy - a $680 million conditional loan guarantee for its Antelope Valley Solar Ranch 1 project, plus partial loans for Topaz Solar and Desert Sunlight projects.

First Solar is well positioned to grow cash flow through an expanding global footprint. If demand remains strong in Asia and Europe and pricing stabilizes - as a recent report from ICIS suggests - First Solar is poised to lead the group higher. Currently trading near $132 per share, First Solar has plenty of room to rise toward the 52-week high of $175.45. Applying a cash flow growth rate of 4% for the rest of 2011, a price target of $152 is achievable.

The Bottom Line
Valuation is just one of several reasons to bask in the solar group now. Lower solar panel prices do squeeze margins, but they also spur demand. First Solar is a low-cost provider able to capture that demand and lead sun stocks out of the June trough. (To learn more about solar, see Spotlight On The Solar Industry.)

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