ESG, or environmental, social, and governance, investing is all the rage at the moment. And so ESG stocks probably have done well so far in 2020.
The “probably” qualifier is required because it’s not clear yet exactly what ESG stocks are supposed to be. For instance, is Tesla (NASDAQ:TSLA) an ESG stock? At first blush, the answer almost certainly would seem to be yes — given the electric car manufacturer’s potential to combat climate change and other environmental ills.
However, Tesla hasn’t had a great track record with labor issues (part of the ‘social’ aspect of ESG investing). Its chief executive officer, Elon Musk, had to pay a $20 million fine to the U.S. Securities and Exchange Commission in 2018. And since then, the Tesla board hasn’t much reigned in his notorious tweeting.
Tesla might have the ‘E’ down pat (excluding the deleterious impact of mining for lithium and other required minerals). The “S” and the “G” are up for debate. Indeed, MSCI, a well-respected rater of ESG stocks, only gives Tesla an “A” — its third-highest grade.
Moreover, there’s another issue as well: too many stocks might be considered ESG stocks. The Vanguard ESG U.S. Stock ETF (BATS:ESGV) contains a whopping 1,460 stocks. That’s about 40% of all companies with a market capitalization over $300 million. Its five biggest holdings simply are the five most valuable U.S. companies.
Overall, is ESG investing with an edge? Or just indexing? And if it’s just indexing, are supposed ESG stocks gaining based on passive inflows into ESG strategies? It’s certainly possible. And if that indeed is what is happening, these three stocks could see a pullback. All three have risks of their own looking to 2021, and rallies that might well be near an end:
Now, let’s dive in and take a closer look at each one.
ESG Stocks That Will Cool Off: Nvidia (NVDA)
As a business, there’s not much to dislike about Nvidia. It might well be the most innovative semiconductor business in the world. And the gaming and datacenter end markets should grow nicely over the long haul. In fact, Nvidia was even rated as the top ESG stock in the market by Investor’s Business Daily.
Indeed, I recommended NVDA stock multiple times in 2019, as the stock rallied from a late 2018 plunge and its “crypto hangover.” But 2021 might be a more difficult story. Valuation is a concern, with the stock trading at 46 times forward earnings. That’s not notably out of line in this market, but it’s a huge, even unprecedented, multiple for a mature chip play.
In addition, 2021 results might be colored by the strong performance this year. Datacenter growth has been explosive as companies rush to the cloud to manage “work from home” environments. Also, gaming revenues received a tailwind from stuck-at-home consumers.
Both tailwinds will fade next year (hopefully) as a semblance of normalcy returns. And management already has admitted as much. In turn, Nvidia’s numbers simply aren’t going to look as strong.
We’ve seen what happens to NVDA stock when datacenter revenue slows: investors get nervous. And with the stock already trading flattish in the last few months of 2020, it wouldn’t be a surprise to see muted returns in 2021.
Plug Power (PLUG)
Give credit where credit is due: Plug Power has had a spectacular run of late. It’s not just the gains in PLUG stock, either, though the 1,800% rally since the beginning of last year certainly is impressive.
Plug Power has materially changed its perception in the public markets. A company that had been a serial disappointer for two decades now appears to be leading the entire hydrogen economy. Collectively, its moves have been on point, and execution is solid. New customers are coming on board, and Plug Power is delivering.
But here, too, 2021 may be more difficult, as I wrote last week. Valuation is a concern, with continued impressive performance seemingly priced in. And like Nvidia, Plug Power got a boost from the novel coronavirus pandemic which likely will fade next year.
As a whole, PLUG stock has been not just one of the best ESG stocks of this year, but one of the best stocks in the entire market. Nonetheless, 2021 will be a tougher climb.
ESG Stocks That Will Cool Off: Enphase Energy (ENPH)
ENPH stock has been one of the few stocks to outperform PLUG stock over the past 23 months. After being “dead money” following its 2012 initial public offering, Enphase stock has risen 24-fold since the beginning of 2019.
Those gains, however, have come in an environment where basically everything has gone right. Optimism toward ESG stocks no doubt has helped the solar supplier. The entire sector has been hot (pardon the pun). Performance admittedly has been solid. Even the change in the White House has boosted ENPH stock and other solar names.
After a year full of catalysts, 2021 at the least will be much quieter. And after the staggering rally, and with ENPH stock trading at 79 times forward earnings, it might be time for a breather.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.