Where to invest, and what to avoid, in the great green shares bubble

Twenty-one years ago, it was the bursting of the technology bubble that sent share prices plunging – at a stroke depleting the wealth of hundreds of thousands who had enthusiastically invested their Isas in the dotcom story. 

Today, there is a fear among some financial experts that another stock market bubble has formed that could result in sharp losses for many. 

This time around, the bubble is green rather than technology based and has been fuelled by the huge appetite for investments in firms that have environmentally friendly credentials. 

This has driven up the stock market value of many companies with a green label – sometimes to levels that are not justified by the businesses’ earnings, now or in the future. 

A big proportion of these companies with stretched market valuations are in the clean or renewable energy space, involved in delivering energy via carbon-friendly means: by wind turbines, solar panels or hydrogen fuel cells. 

Most are US companies but some are UK listed. Many form the portfolio backbone of renewable energy investment trusts whose shares are trading at a premium to the value of their underlying assets. 

In other words, investors now buying into these trusts are paying over the odds to get exposure. A risky strategy – and painful if trust asset prices fall. 

Russ Mould, investment director at wealth manager AJ Bell, is among those who is concerned by the green bubble.

‘This is definitely an area where investors need to take care,’ he says. ‘The focus on environmental, social and corporate governance investing, coupled with the market’s love of a shiny new narrative, means that many companies badged as green or clean energy have valuations that look incredibly stretched.’ 

He adds: ‘As the great investor Warren Buffett once said, ”A pack of lemmings looks like a group of rugged individualists compared with Wall Street when it gets a concept in its teeth.” 

It’s a view reiterated by Alan Miller, chief investment officer of wealth manager SCM Direct. He says: ‘The area of renewable energy has become very fashionable. 

‘Normally, when something becomes popular, it leads to too much money chasing often illiquid stocks which then become overvalued, leading to investors receiving dismal future returns.’ 

Some experts say the exceptional performance of the £6billion exchange traded fund iShares Global Clean Energy over the past year is evidence of a bubble. 

Tracking the performance of the S&P Global Clean Energy Index – a basket of 30 of the largest global companies involved in the clean energy sector – it has seen its share price increase by more than 80 per cent. This is despite the price falling back in recent weeks. 

Wealth manager Interactive Investor removed the fund from its ethical growth portfolio last year because ‘it had done too well’ according to Dzmitry Lipski, its head of fund research. 

‘We still like it,’ he adds, ‘and it remains one of our top 40 rated ethical funds, but other holdings in the growth portfolio had exposure to clean energy and we didn’t want to have too much exposure to just one green sector.’ 

Jeremy Thomas, head of global equities at fund manager Sarasin & Partners and co-manager of the Responsible Global Equity Portfolio fund, is more forthright.

‘Would I buy this fund now?’ he asks. ‘No,’ is his stark answer. His view – and that of others – is that the valuation of many of the companies that form this index are way out of kilter with the rest of the market. 

In other words, horribly overvalued. Indeed, one of these 30 companies – US-listed hydrogen fuel cell specialist Plug Power – has shares that, according to AJ Bell’s Mould, are trading at ‘crazy valuation levels’. In other words, avoid like the plague. 

Yet Thomas stresses that just because price bubbles exist in specific parts of the green investment sector, it doesn’t mean the whole green investment universe should be avoided. 

He says: ‘There are areas such as hydrogen fuel cell development where current share prices are based more on speculation than reality. But if you are selective and cautious about the green sectors and companies chosen, you can still make money.’  

Jupiter’s Jon Wallace says  there are plenty of businesses that are providing solutions which will clean economies and reward long-term investors

Jon Wallace, co-manager of investment trust Jupiter Green, agrees. ‘Picking long-term winners is key,’ he says. ‘We’re multi-green which means there are themes and companies we’re not comfortable holding because they don’t offer value or their shares are too hot. 

‘But there are plenty of businesses we like that are providing solutions which will clean economies and reward long-term investors.’ So, what are the green companies and funds that you should be wary of – and which ones provide the opportunity to make solid returns?

GREEN FIRMS AND FUNDS TO AVOID 

For green investors, many of the companies to avoid are listed on overseas stock markets, so would not probably be among their first choices anyway. 

But the companies will appear in the portfolios of some green funds available to UK investors – so at the very least warning bells should ring if they are a top ten fund holding. 

‘Hot’ green companies include the likes of Plug Power and energy technology company Enphase Energy. Over the past year, the share prices of these two companies have risen by an extraordinary 938 per cent and 255 per cent respectively. 

Says Mould: ‘Enphase Energy may be popular, but it looks unattractive on valuation grounds.’ 

Without getting too technical, its shares currently trade at some 75 times the next 12 months’ forecast earnings. This price earnings ratio, as it is known in the City, is extraordinary on any level and screams: the shares are overpriced. 

Another ‘green’ company that Mould says the current market valuation ‘is hard to stomach’ is electric car manufacturer Tesla. 

Mould’s comments are biting: ‘It has a market capitalisation of $686billion (£487billion) even though it makes no money actually making cars; does so only by selling carbon credits; has a global market share in autos that is a rounding error; and faces ever-growing competition in its core area of making electric cars.’ 

He adds: ‘It’s also run by a maverick [Elon Musk] and fails most corporate governance screens you would care to run; is encountering increased questions over its build quality; and has just spent more on bitcoin than it spends on R&D in a year.’ 

Tesla is a top five holding in the country’s biggest investment trust – the £19.4billion Scottish Mortgage, managed by Baillie Gifford. 

Other electric car manufacturers where valuations look heady include Nikola and Nio whose shares are both listed in the United States. Over the last year, the respective increases in share price are 79 per cent and just over 1,000 per cent. 

UK-listed companies whose shares are best avoided include Sheffield-based hydrogen energy specialist ITM Power. Its shares are up in value by more than 300 per cent over the past year. 

SCM Direct’s Miller says the company’s valuation defies logic. He explains: ‘This is a company that is capitalised at £2.7billion, but generated revenue of just £3.3million last year. By 2023, revenues are not expected to be much more and it is still losing money.’ 

Other UK-listed companies that investors should tread cautiously around are investment trusts that generate an attractive income from renewable infrastructure – such as wind farms or solar panels. 

The income comes from a mix of selling electricity into the grid and government subsidies. Although the income is attractive, it is mitigated by the fact that the shares of these companies are expensive – often trading at a premium to the value of the underlying assets.

For example, Greencoat Wind offers an annual income equivalent to 5.6 per cent. But its shares stand at a 12 per cent premium. Foresight Solar offers an annual income of 6.7 per cent but its shares also trade at a near double-digit discount. 

‘At the end of the day, some investors will be happy to pay a hefty share price premium for access to such attractive yields,’ says Jason Hollands, director of wealth manager Tilney. ‘Others won’t.’ 

Last week, investment trust analysts at Investec rated Greencoat Wind’s shares a ‘buy’.