After a long fallow period out of the investor spotlight, solar-power stocks are back — with a vengeance. 

On April 9, shares of First Solar (Nasdaq: FSLR), the industry’s largest player with a market value of $3.25 billion, rose a stunning 46% in just one day, taking a slew of solar-focused exchange-traded funds higher in sympathy. Yet a deeper look behind the rally should give investors pause.

Underappreciated profit streams
I took a look at First Solar a year ago, when shares were trading near $20, and noted that “the fact the consensus 2014 earnings-per-share forecast remains above $4.50 tells you that many analysts aren’t paying attention to their earnings models at this point.” Indeed, shares fell even lower before eventually perking up as more analysts started to understand the company’s robust earnings power.

The major catalyst for this stock‘s surge was a company-issued 2013 profit forecast that was well ahead of the consensus view. Most analysts still assumed that First Solar would deliver a more tepid profit outlook when the company held its annual analyst day with the Wall Street community.

Yet if you dig deeper into what the company actually discussed, there are reasons to think that long-term cynicism around this business model is likely to re-emerge.

#-ad_banner-#Thanks to Desert Sunlight, a major project expected to be partially completed in 2013 instead of 2014, First Solar now expects to earn $4.25 a share this year on roughly $3.9 billion in recognized revenue. However, many analysts expected that project to appear only in 2014 sales and profits. As a result, First Solar now says the project timing will lead to 2014 sales of $3.8 billion and earnings per share (EPS) of around $3.25. That’s a bit lower than previous guidance.

Note that this is lower than the $4.50 EPS I had been anticipating a year ago, an estimate that was predicated in part on the Desert Sunlight project being completed in 2014. Thanks to opportunities in place for First Solar, management says sales could reach $4.5 billion by 2015 and EPS may approach $5 or $6 by 2015. 

Trouble is, the company is counting on its ability to convert 80% of its current potential sales opportunities into actual orders. And in the solar business, that sales conversion rate is usually far lower, below 50%. So First Solar’s multiyear guidance leaves little margin for error. First Solar already has $1.6 billion in order commitments for 2015, meaning the other $2.9 billion the company hopes to generate that year will come from yet-to-be-signed customers.

The company’s ability to lock up that new business depends on a series of technology improvements to its thin-film solar technology. If achieved, these moves would lower the company’s cost per watt by 40% to around $1 per watt. Accounting for the lower energy conversion efficiency of thin-film solar compared with rivals’ traditional polycrystalline technology, that price point is crucial for First Solar to retain its competitive edge. 

Raffi Garabedian, First Solar’s chief technology officer, thinks the company will surpass rivals on a cost-per-watt basis by the end of next year. That forecast appears to assume that rivals don’t make further progress with the traditional polycrystalline approach. Specifically, First Solar’s thin-film technology converted 12.9% of sunlight into electricity in 2012, though the company expects to boost that figure to 14.9% by the end of 2014 and 17.2% by 2017. That’s a 33% improvement over five years, which would be very impressive. 

Price pressures?
First Solar has done a remarkable job of securing major power supply contracts in the Sun Belt states. The Desert Sunlight project, for example, will generate 550 megawatts of power once it is up and running. Yet it’s increasingly clear that power companies are holding these projects to a higher hurdle rate, which means that First Solar’s future contracts will likely need to be pursued at lower prices. It’s unclear whether analysts are accounting for that. 

Moreover, First Solar will need to do a better job of landing international contracts. As analysts at Morgan Stanley recently noted, First Solar’s “positioning is weak or unclear in key growth markets.” Analysts at Goldman Sachs echo that concern: “(First Solar has) execution risk on what is now a much higher bar, which we believe hinges on achieving at least 1 gigawatt of projects in emerging markets, where contracted backlog is limited and earnings potential uncertain.”

Make no mistake, this is an outstanding company that has managed to deliver solid financial results in an otherwise decimated industry. And solar power is becoming ever more viable, thanks to serial cost reductions. But April 9’s stunning rally appears overdone. 

Note that as of the end of March — 16.4 million shares, accounting for 27% of the trading float — were held in short accounts. The April 9 rally was surely due in part to short covering and probably would not have surged quite as much if the stock had not been so heavily shorted.

If you are a fan of this company’s business model, as I am, then wait for a better entry point, perhaps closer to $30.

Risks to Consider: The short covering process may not be over, so further short covering could push this stock above $40 in the near term. 

Action to Take –> Investors often fail to distinguish between a company and its stock. Although First Solar will be a long-term industry winner, the operating environment for solar power companies is still quite challenging, and you’re better off owning a stock like this when those challenges are better reflected in the share price.

P.S. — Solar power is just one of the energy plays we’ve got our eye on. Another one that could potentially be even more profitable could mark the end of OPEC as we know it, while easily turning a $5,000 investment into $50,000 or more in the next five years. Go here to learn more.