Alternative energy: How to bet
Investor enthusiasm is high, here's what to look for, and what to be wary of.
NEW YORK (CNNMoney.com) -- Everyone wants to know where to put their money in alternative energy.
That's natural given high oil prices and increasing talk about an energy crunch. And big money is already moving in. Many analysts are comparing the flood of venture capital and institutional money to the dot.com days.
What can a retail investor do? We asked several pros what to look for - and what to watch out for - when diving into renewable energy.
Do your homework: Just like the dot.com boom, and the railroad boom a century before it, many start up renewable companies won't make it.
"Make sure there is some substance behind the smoke," said William Buechler, President of Barclay Partners Asset Management, a California-based company that controls $250 million in assets. "You can't get excited on the hope of the industry and ignore the fact that they still need to make money."
Buechler says a company with a price to earnings ratio over 50 is probably overvalued in this sector.
He says to watch cash flows, and to see who the clients of the company are to make sure they are solid.
He pointed to companies that do business in California, where there are mandates to use renewable energy, as firms which probably have a solid client base.
Watch oil ... and oil politics: It's not all about core business models or market forces.
The viability of your investment will depend in large part on the price of oil.
Many analysts say alternative energy needs to have oil over $50 a barrel - where it is now but just barely - for it to be commercially viable.
So a bet on alternative fuels is really a bet that oil prices will go higher, said Neal Dingmann, an energy analyst at Dahlman Rose & Co., a New York-based energy investment boutique.
Or, it's a bet that the government will keep or raise subsidies, which most technologies like wind, solar and biofuel still need to compete.
And then there is the possibility of mandatory carbon limits, which would further help alternatives.
Of course, if oil goes back to $30 a barrel, the whole sector may fade away.
Diversify: Spread your investments between wind, solar and biofuels, the experts advise.
And don't just pay attention to the small companies with big ideas. Big companies GE (Charts), BP (Charts), DuPont (Charts), and Archer-Daniels-Midland (Charts) are players in the sector too.
The fact that a fairly small portion of their earnings come from alternatives (with the possible exception of Archer) insulates them from downturns, the pros point out. On the other hand, range of operations also prevents their stock from benefiting greatly when good times hit one particular sector.
Think long term: Most models for success in the sector rely on government subsidies keeping companies afloat until they can gain enough scale to become competitive. Or until oil prices move substantially higher. Or until there are financial penalties for carbon emissions.
Even if these things were a sure bet (which they aren't), none will happen overnight.
"It's a rapidly growing market, but be patient," said Scott Brown, chief executive at New Energy Capital, which invests in alternative energy projects like power plants.
Brown said that in the short term commodity prices for things like oil and corn -the base stock for ethanol in the U.S. - are likely to remain volatile.
But in the long term, "If you're looking at 10 years out, now is probably a good time to buy," he said.