The Holy Grail of investing is finding the next paradigm-shifting sector that changes the way the world works and offers potentially boffo investment returns in the process. The last great gold rush was the dot-com boom; the next one might already be here-green technologies, a vast sector running the gamut from renewable energy sources to clean technologies that enables businesses to boost performance while minimizing their environmental impact.

Many green tech stocks zoomed last year, perhaps none more so than those in solar, where a slew of initial public offerings-many from China-created a buzz that helped propel share prices at many solar companies by triple-digit amounts. Meanwhile, some of the sharpest minds in venture capital are making big-time bets on green tech. One alternative energy proselytizer is Vinod Khosla, a co-founder of Sun Microsystems, then a general partner at the heavyweight Silicon Valley VC firm Kleiner Perkins Caufield & Byers (early supporters of Amazon and Google) and later founder of his own VC firm. And current Kleiner Perkins partner John Doerr calls green tech possibly the greatest economic opportunity of the 21st century.

Effusive statements like that are commonplace in this sphere. "We're in the first inning of a 50-inning ballgame," says Rafael Coven, managing partner at Cleantech Indices, a developer of indexes tracking green tech stocks. "It's not dissimilar to the advent of the information age because water, energy and the environment are issues facing the entire world."

That's heady stuff. But many green solutions are expensive, alternative energy still accounts for just a small portion of global energy output, and enthusiasm for green investing might have gotten ahead of itself. Witness the gut-wrenching 20% to 50% price declines in solar and other green tech stocks during the early weeks of 2008, coupled with 15% to 20% losses in green tech-oriented mutual funds and exchange-traded funds. And like the Internet boom in the '90s, green tech is an evolving space filled with speculative companies that have little or no profits. In short, green tech can be volatile. Or worse.

Eric Janszen, a former venture capitalist who now runs an online investment Web site called iTulip, wrote in his February cover story for Harper's Magazine that alternative energy is the next investment bubble waiting to burst, fueled by government subsidies and by irrational exuberance from both VCs and market investors alike.

So, what's it going to be for green tech: bonanza or burst bubble? Someday, it might be the latter. But with global warming the catch phrase of the new century, with rising energy prices due to global economic growth and with government policies encouraging eco-friendly solutions, green tech likely will have staying power for the foreseeable future. The trick is finding the right ways to play it.

Fundamental Drivers

The International Energy Agency forecasts that worldwide energy demand will jump more than 50% by 2030 unless governments change their policies. China and India combined would account for nearly half of that rise, with coal use set to grow most rapidly in those countries. The agency says the expected reliance on fossil fuels would boost their energy-related emissions of the greenhouse gas carbon dioxide by 57%.

Oil demand is rising at a time when many mature oil patches around the world are being depleted and some of the most promising new finds are in hard-to-reach places that make them costly. The fear is that we're consuming more oil than we can replace, which could put long-term upward pricing pressure on it. Additional concerns center on the nationalization of oil reserves by some producers, as well as the political uncertainty surrounding major oil exporters such as Iran and Venezuela.

Pollution and energy security worries make alternative energy more appealing, but renewables won't go mainstream unless they become more cost competitive with fossil fuels, and for the most part that still depends on regulations and subsidies. For example, Europe's thriving wind and solar markets are built on a system of "feed-in tariffs" that require utilities to buy a certain amount of electricity from renewable energy sources.

In the U.S., the Energy Policy Act of 2005 created tax credits to support renewable energy sources. They were extended in 2006, but were left out of the 2007 national energy bill because of political wrangling. At press time, Congress was trying to find ways to extend the tax credits. Meanwhile, 26 states have set standards requiring utilities to generate certain percentages of electricity from renewable sources (two other states have voluntary standards).

The beauty of renewable energy sources such as solar and wind is that they're free. The associated costs are tied to the technology required to harness them into usable energy. "This is a high-tech area, and tech costs go down over time," says Rob Wilder, CEO at WilderShares, a developer of green tech indexes. "Solar, wind and geothermal costs are all heading in a direction that's fundamentally different than oil."

Here Comes The Sun

Solar power produces less than 1% of the world's energy, yet it occupies an outsized place in the image of renewable energy in the U.S. partly due to the excitement that surrounded solar stocks in 2007. But solar is poised to play a larger energy role with the continued rollout of photovoltaic (PV) panels that use polysilicon cells to convert sunlight to electricity, and massive projects using concentrating solar power (CSP), a technology that uses arrays of giant mirrors to collect sunlight, which heats water to create steam that powers turbines.

According to the most recent data from www.solarbuzz.com, a Web portal on solar energy, the installation of global photovoltaic solar panels rose 19% in 2006. Germany by far is the largest solar market, followed by Japan. The U.S. itself is a fast-growing solar market where the installed megawatt base leaped 125% in 2007 from the previous year, according to the Solar Energy Industries Association.

Electricity from rooftop PV panels costs less than 22 cents per kilowatt-hour on average, while U.S. residential electricity costs can vary from 6 to 23 cents. PV panels depend on tax credits to be economically feasible, as does CSP, which generally costs about 12 cents per kilowatt-hour. There are several existing CSP projects in the world, and last year the California utility Pacific Gas & Electric announced a 25-year deal to buy solar thermal power from a gigantic nine-square-mile solar park to be built in the Mojave Desert by Solel, a private Israeli company.

But the solar action on Wall Street largely shines on PV panel makers. Leading players include Suntech Power Holdings, Sunpower and First Solar, three stocks with distinct advantages whose prices all soared last year, but then crashed hard in early 2008.

China-based Suntech benefits from production costs that are cheaper than those of most rival makers of silicon-based panels, and stands to cash in from China's environmental cleanup efforts. (It's providing solar power to the main stadium at this summer's Beijing Olympic games.) But the 18% energy efficiency rate of its panels is less than the 22% rate from California-based Sunpower, which Guinness Atkinson Alternative Energy fund co-manager Edward Guinness says is the industry's most energy-efficient solar panel maker. He considers Suntech more of a commodity play, and that's reflected in the company's price-to-earnings multiple on forward earnings (25 times for Suntech's versus 31 times for Sunpower). "There will be room for both," he says, "but in the long run, I favor higher efficiency."

Phoenix-based First Solar is an early leader in PV panels that use thin films of cadmium-telluride semiconductors to make electricity. Thin-film panels are less expensive than silicon-based panels and are more cost-effective for large utility-scale installations; the downside is that they're only about half as energy efficient as silicon panels. But First Solar's low-cost model excited investors so much that the stock skyrocketed more than 1000% from its November 2006 IPO until its all-time high of $283 last December. By early February of 2008, however, it had dropped 38%.

Tilting At Windmills

Wind power is already big in Europe and India, and should get a huge boost from China's aggressive plans to generate 10% of its electricity from renewable sources by 2020, including a thirtyfold increase in wind power to 30 gigawatts. "We expect wind energy to be the fastest-growing form of electricity generation over the coming 10 years," says Jens Peers, who heads the eco-investing team at KBC Asset Management International and who is the lead portfolio manager of the Calvert Global Alternative Energy fund. He says that global installed wind farm capacity is forecast to grow 15% on a compounded annual basis through 2015.

Wind-generated electricity costs about 5 cents per kilowatt-hour, which compares favorably with natural gas, but is still more than coal.

One of Peers' favorite stocks is Vestas Wind Systems, a Copenhagen-based wind company with more than 33,500 wind turbines in 63 countries that produce more than 50 million megawatt hours of electricity a year, or enough to supply millions of homes. He also likes Hansen Transmissions International, a London-traded company that makes gearboxes for wind turbines.

Closer to home, wind farms constitute only about 1% of the U.S. electricity supply. But the growth potential is enormous, given the country's three coasts and a wind belt that runs from Texas (by far the nation's leading wind-power source) to North Dakota.

There are only a few wind-power companies in the U.S. market, and none are pure plays. Among them is American Superconductor Corp., which among other things supplies electrical systems used in wind turbines and sells products that regulate wind farm voltage so it can be hooked up to the power grid. Zoltek makes lightweight carbon fiber material that enables wind-turbine blades to be longer and stronger than fiberglass blades. And the largest wind turbine maker in the U.S. is General Electric, whose wind business is thriving even if it represents only a speck on its mammoth balance sheet.

Hot Rocks And Other Things

One of the major drawbacks of solar and wind is that they're not always "on." Geothermal, on the other hand, is a never-ending energy source that captures the thermal heat trapped within rocks beneath the earth's surface. The ample supply of geysers and hot springs in the western U.S. help make it the world's largest geothermal energy source, and geothermal is the country's third-largest renewable energy source after hydro and biomass, according to the Geothermal Energy Association.

There aren't a lot of publicly traded geothermal companies, but Ed Guinness from the Guinness Atkinson Alternative Energy Fund likes Ormat Technologies, a Reno, Nev.-based company with 10% of the world's installed geothermal capacity, more than 75 patented power technologies and low operating costs. The company's shares recently traded down about 30% from their 52-week high; shares traded at 34 times 2008 earnings that are forecast to grow nearly 80% over last year.

Ethanol stocks shined in 2006, but have since fallen mightily on concerns of oversupply and rising corn prices fueled in large part by the ethanol frenzy. A clean energy research report from Morgan Stanley said that ethanol fundamentals will likely deteriorate this year because of a commodity squeeze, supply imbalance and a U.S. recession.

The renewable energy space is filled with enticing yet speculative companies that include makers of biodiesel; producers of enzymes that convert cellulosic feedstocks to biofuels; and manufacturers of fuel cells. These aren't for the faint of heart. "Fuel cells have been astoundingly successful at losing money the past seven years," says Rob Wilder of WilderShares, who nonetheless says they make up 10% of his Clean Energy index.

Clean Tech

The clean tech umbrella covers myriad businesses ranging from farm-efficiency technologies and electricity-usage meters to industrial sensors and controls. Clean tech is now the third-largest venture capital sector, says Rafael Coven from Cleantech Indices, who acknowledges that not all of these investments are well thought out.

"There's money going into good and bad deals," he says. But Coven adds that clean tech on the whole is filled with demand-driven opportunities on a global scale that provide long-term opportunities.

"That said, some of these businesses won't grow at exponential rates like Internet companies did," he says. "Some will take more time to scale up."

John Quealy, an analyst at Canaccord Adams, says one of his top choices in the clean tech space is Itron, whose products help utilities operate more efficiently. It's the world's leading electricity metering company and the second-largest gas metering company, prompting Quealy to call it the Microsoft of metering.

Itron's stock doubled last year before it imploded in November because of delayed purchases Quealy blames on the product-cycle timing of one of its next-generation products. He says an expected product-cycle upgrade and a recent big contract to supply smart meters to California's largest electric utility sets it up for solid improvements in this year's second half.

Itron is also a top pick of Hilary Kramer, president of GreenTech Research, a hedge fund focused on alternative energy and clean tech investing. One of her favorite themes is companies that help put alternative energy on the grid and that help manage the energy after it's on the grid, a list that includes American Superconductor, Comverge and Enernoc.

Kramer's fund is also big on companies that will play a role in China's expected wind boom, and it likes waste-to-energy companies such as Covanta Holding Corp. and Environmental Power Corp. The latter, one of the few publicly traded companies that converts livestock waste to energy, turns methane from manure (a more potent greenhouse gas than carbon dioxide) into biogas. But the company's small float and recent $4 stock price make it a risky investment.

The Long Haul

As with the Internet boom, green tech offers both hope and hype, and will spawn both fundamentally sound businesses that profoundly improve the world, and speculative companies that never deliver the goods. And it's going to have its ups and downs.

"We're approaching this as a very long-term, viable and profitable universe with huge upside potential," Kramer says. "But you just can't do it by riding the horse upwards. My belief is you have to be very nimble and quick to grab opportunities both on the upside and downside."

For investors who aren't into shorting stocks, the best bet is to grab some of the industry leaders--the market's recent downturn brought some of them back to reasonable levels--and be prepared for the long haul. Other options include green tech-focused mutual funds such as the Calvert or Guiness Atkinson offerings, or some of the PowerShares ETFs based on the Cleantech or WilderShares indices.

If green tech is still in the early innings, it's shaping up to be an interesting ball game.