When it comes to the U.S. energy mix, solar power seems to be a no-brainer. It is an infinite, clean source of energy. And the one key reason which previously prevented solar from claiming a more dominant place in the U.S. energy market, economics, is rapidly improving. Solar stocks have struggled this year, as names like First Solar (Nasdaq: FSLR) and SolarCity (Nasdaq: SCTY) have significantly underperformed the broader market in 2016. Year-to-date, First Solar and SolarCity shares have declined 25 percent and 62 percent, respectively, but the sell-offs seem far overdone.

It is high time for analysts and investors to take solar companies more seriously as major players in the energy sector. Industry research is widely confirming a trend which investors should take note of: the potential for solar power is tremendous. Investor sentiment is poor right now, but that can change quickly. Solar companies are proving their worth as viable businesses, meaning these stocks may not be this cheap for long.

Key factors underpinning the solar revolution

In a 2014 study by consulting giant McKinsey & Company, solar installations have risen at a 50 percent compound annual rate since 2006. Continued growth is all but assured; Americans are widely embracing new, renewable sources of energy. The extremely harsh environmental effects of coal are the leading reason why the coal industry stands on the brink. Even natural gas, which was initially viewed as the fuel of the future, now has its share of critics. The technology that unlocked natural gas and led to a boom in domestic natural gas production—hydraulic fracturing—is now being debated due to the sharp increase in earthquakes across many parts of the country where natural gas production is rising. According to the McKinsey study, solar adoption rates in the U.S. and Europe have more than quadrupled since 2009.

There is massive growth potential for solar, both at the consumer and enterprise levels. At the consumer level, the extension of the Solar Investment Tax Credit (ITC) is a huge tailwind for the industry. In Dec. 2015, the U.S. Congress extended the ITC, which provides 30 percent tax credits for both residential and commercial projects through 2019, 26 percent tax credits in 2020, and 22 percent in 2021. This will continue to be a key incentive to switch to solar power. Separately, major U.S. companies have agreed to meaningfully boost their use of renewables. For example, McKinsey reports that Wal-Mart Stores (NYSE: WMT), the biggest retailer in the world, plans to switch to 100 percent renewable power by 2020, up from 20 percent presently.

Solar’s growth potential is extremely attractive for investors, and it bodes very well for First Solar and SolarCity. These two solar stocks stand to benefit from what appears to be a clear, undeniable structural change taking place in the U.S. economy. Even better, because the solar industry has vastly improved its cost controls in recent years, the investment proposition is highly compelling. As the McKinsey report states, the average price U.S. consumers pay to install rooftop solar panels has fallen from $7 per watt in 2008, to $4 in 2013. Indeed, improving costs are a key component of solar’s revival.

First Solar’s sales soared 80 percent last quarter, and perhaps more importantly, the company is solidly profitable. It earned a $262 million gross profit last quarter, compared to just a $38 million gross profit in the same quarter 2015. Going forward, First Solar expects as much as 14 percent revenue growth in 2016. This would represent a significant acceleration in revenue growth, and a strong indication that First Solar is capitalizing on the solar boom. Continued growth is very likely, as First Solar has the financial flexibility to continue investing in its growth—the company has nearly $2 billion in cash in the bank which it can use to finance future projects.

For its part, SolarCity is a more speculative bet than First Solar. As an investment, it epitomizes a ‘high-risk, high-reward’ proposition. That is because its underlying financial results are much more volatile than more established players like First Solar. SolarCity’s revenue soared 61 percent in the fourth quarter, but it lost $56 million last year. Still, the company expects to become cash-flow positive by the fourth quarter of this year.

The good news is that  The average price target for First Solar is currently $77 per share. At its current price of $49 per share, that represents 57 percent upside potential for the stock. Meanwhile, analysts expect Solar City shares to rise 26 percent.

 

Conclusion

There is an abundance of data that suggests the market potential for solar power in the U.S. is massive, and is currently under-appreciated. Whereas the economics of the solar business were crushed for many years due to a flood of cheap Chinese imports, this is beginning to change. Solar companies are vastly improving their profitability, and they are still in the infancy of their future growth trajectories. The implications are clear: solar is here to stay, and the boom is just beginning.

First Solar stock in particular looks like far too cheap. At $49 per share, the stock is valued at just 9 times earnings per share. This is less than half the valuation multiple that the S&P 500 currently receives. As a result, First Solar could earn significant future returns for investors.

Companies to watch

Trina Solar (NYSE: TSL) Trina Solar stock declined 33 percent in the past one year, despite the fact that it has expanded its profitability along with its peer group. Trina Solar earned $0.69 per share in profit over the past 12 months. This means the stock, at its current price of $8.15, is valued for a modest 11 times EPS. Like First Solar, Trina is very cheap, especially in comparison to the S&P 500.

JA Solar (Nasdaq: JASO) The parade of absurdly cheap solar stocks continues with JA Solar, a stock that has lost 20 percent of its value over the past year, despite the fact that the company earned $1.62 per share in profit over the past year. This means JA Solar shares trade for just 5 times earnings—which could signal a screaming bargain.

JinkoSolar Holding Co. (NYSE: JKS) After losing 28 percent of its value over the past year, JinkoSolar is yet another cheap solar stock, trading at just 6 times EPS. The key takeaway for investors is that the solar industry as a whole is being under-appreciated by the market. Investors are clearly not projecting much growth for solar, despite the overwhelming evidence that solar could be the world’s next great growth engine in the energy industry.

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.