Investors gobbled up solar stocks last year, setting off sharp jumps in some and raising fears that the industry could be vulnerable to a downturn.
"Valuations are getting pretty rich," said Mark Manley, an analyst with Natixis Bleichroeder. "These stocks have been some of the top performers of 2007, and I think that there is a lot of potential for solar over all and the space will continue to grow, but that may already be reflected in some of their prices."
Leading the pack is First Solar, which saw its value surge eightfold last year to reach a market capitalization of about $20 billion.
First Solar is a leading maker of thin-film photovoltaic cells, which convert sunlight into electricity. Investors flocked to its stock as it opened new manufacturing plants and promised to nearly double its revenue in 2008.
But thin film remains less than 10 percent of the total solar manufacturing market. And despite output growth of about 50 percent in 2007 to more than 12,000 megawatts, solar energy still represents well below 1 percent of the world's generation capacity.
So far, most of the demand for solar power has come from Europe, where countries like Spain and Germany have implemented generous subsidies to support it. Still, the appetite of the United States and that of Asia, particularly China, has been growing.
"That means that there is a tremendous market penetration opportunity," said Pavel Molchanov, an analyst at Raymond James. "As the market develops, growth rates should remain very high."
That growth potential has lifted the price for solar sector companies above 35 times their projected 2008 earnings, compared with about 14 times earnings for the Standard & Poor's 500 Index. First Solar is trading at a lofty 130 times earnings.
While First Solar has caught the eye of investors looking to jump to the leading edge of the technology, thin-film photovoltaic cells are not likely to displace silicon-based technology anytime soon. Silicon arrays are more suitable than thin film for homes and businesses, while either technology can be used for larger, utility-scale projects.
"That is the versatility of silicon-based solar technology, but there is definitely room in the market for both products," Molchanov said.
The silicon-based companies, like Q-Cells in Germany, Suntech Power Holdings in China and SunPower in the United States, posted sharp stock gains of 150 to 250 percent last year.
But tight supplies of silicon have crimped growth and threatened profit margins for those companies, as silicon prices have risen more than six-fold in three years.
Silicon supplies should become more ample in 2009 as new production capacity comes on line, analysts said.
"And once people believe that the silicon shortage will abate, that will trickle through to the solar stocks," said Edward Guinness, co-manager of a Guinness-Atkinson alternative energy fund.
Guinness said he preferred the larger players in the sector, including Q-Cells, Suntech and SunPower, although he said SunPower's valuation at about 60 times 2008 earnings was a concern.
Among the smaller players, Motech Industries in Taiwan and DayStar Technologies in the United States, a thin film producer, are attractive, he added.
Malchanov said he also was positive on many players in the sector, especially SunPower and Trina Solar, a vertically integrated Chinese company that is trading at a relatively modest 18 times its expected 2008 earnings.