Stem (NYSE:STEM) is aiming to shake up the energy storage industry. Up until now, it’s been difficult to store and distribute energy on a mass scale with existing battery technology. Using a clever approach, Stem is seeking to profit from this gap in the market and boost STEM stock in the process.
There are several ways to attack this problem. One approach is to try to revolutionize everything all at once, as next-generation battery maker QuantumScape (NYSE:QS) has done.
QuantumScape’s management claims it has a battery design that will blow the existing commercial designs out of the water. If QuantumScape can deliver the goods, QS stock will be a “home run” investment. But if the company is overstating its capabilities — as bears allege — there’s a decent chance that its shares will end up being worthless.
Investing in such a company is gut-wrenching and requires iron conviction and skillful risk management.
On the other hand, there are companies seeking to make logical sequential improvements to existing technology, such as Stem.
Stem isn’t trying to rebuild batteries or the electric system from square one. Rather, it is looking for the inefficiencies and flaws in the existing designs and grids. Stem steps in and optimizes systems, saving energy for consumers and receiving payments in exchange. This is an eminently feasible, practical, and scalable business model.
The Green Opportunity
InvestorPlace Senior Investment Analyst Luke Lango recently highlighted an amazing stat about energy waste: Renewable energy currently loses a great deal of its power output because of a shortage of adequate storage capacity and of smart systems that route energy to the right destinations. In California alone, wasted renewable energy could power tens of thousands of houses annually.
Stem can help solve this problem by setting up batteries. These aren’t just generic batteries, however. Stem has proprietary artificial intelligence (AI) driven software that enable these batteries to be utilized as efficiently as possible.
Stem analyzes data from more than 40 different utilities. Using AI, it helps determine the optimal times to draw power from batteries, on-site energy systems, or the public grid. Stem can reduce energy usage by up to 30% through this approach.
This seems like a perfect business model for the Green Revolution. For one thing, deployments of renewable energy are surging. The Biden administration’s infrastructure initiative is likely to add even more juice to that trend.
And efficiency is a huge focus for companies. Everyone wants to have a higher environmental, social, and governance (ESG) rating. Companies that use technology such as Stem’s to reduce their electricity consumption benefit from the technology because it saves money and improves their ESG profiles.
Stem Should Eventually Enter the Black
Unlike a lot of firms that entered the public markets through special purpose acquisition companies (SPACs), Stem is already generating meaningful revenue. It isn’t just a company with a prototype and some fancy PowerPoint slides.
In fact, Stem is on pace to generate around $150 million of revenue in 2021. Additionally, as of March 31, the company’s contracted backlog included $221 million of projects, while its 12-month pipeline amounted to $1.4 billion.
The numbers show that Stem’s products have already been widely adopted, with its batteries and cutting-edge software generating significant revenue.
But the valuation of STEM stock, particularly after its recent rally, may be excessive. Stem’s market capitalization is now greater than $4 billion, so it has a pretty huge sales multiple. Additionally, Stem’s profit margins are still anemic, as its hardware business is not very profitable.
Over time, Stem, which is still in the red, should become much more profitable as it earns more of its revenues from selling software and services to existing customers, rather than new deployments. But that process will take a few years to play out.
The Verdict on STEM Stock
A month ago, I declared that Stem was one of the most promising green energy plays out there. I stand by that view. However, the stock has advanced from $27 when that article was published to around $36 this morning.
It’s going to take years for Stem to really reach its potential. So we aren’t going to know if the company’s fundamentals are keeping up with that potential for quite some time.
With that in mind, be wary of quick run-ups by names like Stem, which is likely to be volatile for some time.
If you want to own STEM stock, buy it on weakness. And consider taking some profits on the shares’ large gains.
With such tactics, investors can lower their average buying prices and reduce their risk.
Stem has a ton of long-term potential, but it won’t be an overnight success either, so the investors who buy its shares will have to be patient.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.