Chill settles on once-hot solar panel companies

— -- Summer may be winding down, but investors holding solar energy stocks are getting one nasty burn. Shares of companies that make solar panels have flamed out this year, missing out on what's been a significant recovery in the stock market.

Market leaders, including First Solarfslr and SunPowerspwra, for instance, are down 12% and 30% this year, even as the benchmark Standard & Poor's 500 index is up 13%. And the Market Vectors Solar Energy ETF, which tracks stocks in the industry, is down 6% this year.

Unlike the big drops in other once-hot stock groups, solar's troubles aren't just caused by speculators rushing out. There are some real problems in the industry behind the sell-off of the stocks:

•A glut of solar panels. Makers of solar panels were so sure demand would surge this year, they went into overdrive producing them, says Christine Hersey, analyst at Wedbush Morgan.

But the flood of supply has swamped demand. Prices of solar modules are in free fall, down about 50% since last year, says Nathaniel Bullard of energy market research firm New Energy Finance. Solar panels now sell for about $2.50 per watt, he says.

•Questions over government subsidies. Thanks to generous programs to encourage green power, European nations have been top buyers of solar modules. However, many are scaling back their subsidies, causing more softness in demand.

Last year, for instance, Spain put a cap on its solar incentive program, causing the demand from a country that accounted for a big piece of the market to shrink 80%, Bullard says. Of even more concern is Germany, the largest solar consumer in the world, which is mulling a cut to incentives to buyers of solar power, Hersey says. "Since Germany is the largest market, it sets the tone," she says, adding some solar companies get 60% of revenue from Germany. The subsidies have become unpopular because much of the money is going to Chinese, not German, solar companies, she says.

•Challenging environment to borrow money for solar projects. Solar installations require significant upfront costs, and companies and consumers are still having trouble getting such loans, says John Hardy of Broadpoint AmTech. Normally, the decline in solar module prices would be enticing, but unless companies and consumers have the cash, such projects may be pushed off, he says.

There are bright sides to the industry's woes. Consumers can install a home solar system for $10,000 on average, says Bullard. While still pricey, it's half last year's tab.

And investors who pick the companies that survive this shakeout will likely be rewarded. "It's a difficult time for the solar manufacturers, but the ones that come out of this will likely be the world leaders," Bullard says.