If you decide to invest in alternative energy, we recommend that you pay attention to these key risks.

Investor interest in alternative energy stocks have grown over the past few years as concern over the environment has grown.

However, many of these alternative energy stocks have limited investment appeal because many of them need a long time to move from the research or concept stage to profitability.

To cut your risk, we recommend that you focus on alternative energy stocks that already have a sound base of other operations. That helps offset the risks of expanding into renewable-power production.

Bonus: What to know before investing in solar alternative energy stocks

The attraction of solar power is obvious for alternative energy stock investing—it offers a source of clean, endlessly renewable energy that has the potential to replace fossil fuels like oil, coal and natural gas. However, like many alternative energy sources, solar power’s vast potential has risk to match. High costs mean many solar power stocks must rely on government subsidies.

Right now, the technology used in solar power isn’t efficient or cheap enough to match the price of oil or natural gas—especially with today’s low oil and gas prices.  

Because of that price disparity, solar power relies heavily on government subsidies and political support. That support is based on environmental “clean” energy concerns and perceptions of climate-change urgency, as well as a push toward energy independence.

Many of these subsidies for solar power stocks seem likely to continue, at least for now, in China, Japan and the U.S., and that’s fuelling demand from utilities for large-scale solar plants. However, solar subsidies have lost support in many countries, including Germany and Spain. Meanwhile, low prices for oil, natural gas and coal make solar power less cost-competitive.

What to know before investing in alternative energy ETFs

If you do decide to invest in alternative energy, we generally recommend that you focus on individual alternative energy stocks instead of an alternative energy ETF. Above all, look for stocks that already have a sound base of other operations—such as a wind-farm operator that also operates natural-gas fired power plants. This diversification helps offset the risks of expanding into renewable-power production.

Themed ETFs like alternative energy or renewable energy ETFs may have a lot of emotional appeal. But when you indulge in theme investing, you may allow a theme or concept to take a central place in your investing decisions. Usually the theme or concept includes some prediction about the future that has some truth in it, and will make noticeable changes in society. You may assume that if you can just get on board with that theme or find an investment with its future tied to it, you are bound to make money.

In other words, you are buying what you might call a “Big Idea” without making certain that a particular investment has a workable business concept, or the management strength and integrity they need to overcome competition and profit from it.

Themes like alternative energy can cause you to overlook crucial details. A key problem is that if the theme is your overriding investment consideration, it’s all too easy to get lazy about the details. You may feel that all the hard work has been done for you. You may come around to the view that the theme is so powerful that you can safely disregard p/e ratios and other measures of value and risk. You may wind up basing investment decisions on offhand projections or self-serving advice from promoters. That can distract you from looking at the stocks (and their fundamentals) that an ETF holds.

Keeping those facts in mind can help you spot stocks with extra potential. But if you let the theme make the decision for you, you are sure to overlook some risks.

You may feel that investing in alternative energy ETFs has the added benefit of letting you support worthy social objectives. But again, you can’t let that dictate your investment decisions. At the same time, brokers like themed investments such as alternative energy ETFs because it gives them a rationale to recommend them to you.

Two alternative energy stocks with a sound base of other business

Here are two alternative stocks we cover in our Wall Street Stock Forecaster newsletter that can give you exposure to alternative energy—but at the same time cut your risk.

General Electric, symbol GE on New York, is one of the world’s largest industrial corporations. GE’s products include major appliances; lighting products; medical imaging equipment; power generation and delivery products; and aircraft jet engines.

GE sells a wide range of environmentally friendly consumer products, including low-wattage light bulbs and energy-efficient appliances. It also supplies wind turbines and solar panels to electrical utilities. As well, its expertise with nuclear power plants should help it profit from the construction of new plants around the world. Nuclear plants generate fewer emissions than gas and coal-fired plants.

GE is a buy.

Ormat Technologies, symbol ORA on New York, designs and makes geothermal and recovered-energy power plants. (Recovered-energy generation captures unused waste heat, such as exhaust from industry, and converts it into electricity.) The company owns and operates its own plants, which it uses to generate electricity for sale, and sells plants to customers around the world.

Geothermal energy taps into heat energy from the earth’s molten interior. Movements of the earth’s crust bring magma, or molten rock, nearer to the surface, where it heats reservoirs of water to create hot water and steam. Geothermal energy companies like Ormat then drill into these reservoirs and use the steam and hot water to drive electricity-generating turbines.

Ormat Technologies is an alternative energy stock buy.

Do you invest a portion of your portfolio in alternative energy stocks? Why or why not?