Investing in lithium stocks and shares has recently gained widespread popularity. With demand for electric vehicle batteries skyrocketing, the price of lithium is exploding. Yet, with the electric vehicle sector still within its infancy, forecasts indicate that the recent surge in demand is only just getting started. That presents an interesting opportunity for investors. So, let’s take a closer look at lithium stocks, their potential, and the risks.

What are Lithium Stocks?

Lithium stocks and shares are companies involved in lithium production through mining, processing, and recycling of the metal. The material typically in the form of lithium carbonate. And Lithium ion batteries have propelled the demand for the metal, in particular for electric vehicles. The higher energy per unit mass makes the technology an ideal candidate for an EV battery. Beyond that, these batteries have a longer life, recyclable components, and better performance in different temperatures.

While the automotive sector may be driving most of the demand, rechargeable batteries are equally used in phones, computers, watches and even medical devices. And with the world shifting towards renewable energy technology, lithium demand is unlikely to change unless there is a significant technological shift that no longer requires the metal.

Companies operating within this space typically fall into one of four categories.

• Mining – As the name suggests, these are the companies extracting the metal from the ground. Lithium is usually mined underground from a mineral-rich brine about ten metres beneath the briny lakes of high-altitude salt flats. And as with any mining operation, the profitability of these companies is ultimately determined by the fluctuating prices of the raw material. Examples of lithium shares that fall under this category include Albemarle and Livent.
• Processing – Once lithium is extracted, it has to be processed to the crystal state before being used. Right now, most of the companies involved in extraction equally process the metal.
• Battery Manufacturing – Captures any business involved in manufacturing lithium ion batteries. This is a pretty complex process. So, most automakers outsource this task to more experienced manufacturers like CATL and LG. However, Elon Musk’s Tesla is one of few exceptions.
• Recycling – This segment is still early stage without many players competing. But as there is a finite amount of lithium on the planet, having the means of recycling old batteries will undoubtedly be paramount one day. Some companies trying to crack this part of the market include Umicore, Li-Cycle, and American Manganese.

In 2020, lithium ion batteries accounted for over 70% of global lithium consumption. And with electric vehicle production now ramping up, that proportion is likely to expand sending the lithium price to potentially new highs. But while that does present a potentially lucrative opportunity, it’s far from risk-free.

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Risks and challenges of Lithium shares

Like every other sector, investing in lithium stocks has its risks.

• Demand & Supply Imbalance – The reason why the price of lithium is skyrocketing at the moment is entirely down to an imbalance between demand and available supply. With the pandemic still disrupting mining operations in Asia, and a war in Ukraine preventing exaction in Eastern Europe, mining companies cannot keep up. But with the prices soaring, other mining businesses are looking to capitalise on the opportunity. And one day, the tables could turn where there is too much supply. In that eventual scenario, the price of lithium and all associated stocks will undoubtedly start falling.
• Price Instability – As a further point to the supply imbalance problem, the metals industry is highly cyclical. And lithium is no exception. Between 2017 and 2018, lithium prices trended up, then trended down until 2020 before reversing once again. This volatility can quickly turn economically viable mining projects worthless.
• Environmental Concerns – One of the reasons lithium has gained widespread popularity is its use for EV batteries. Electric vehicles are considered far more eco-friendly than internal combustion engines. However, the process of extracting lithium from the Earth is not. And with global warming becoming an ever-present threat, an alternative battery technology may be adopted. In this scenario, the primary use-case for lithium disappears, sending its price and, in turn, shares plummeting.

Key Financial Metrics to Watch

Below are some key ratios I believe investors should look at when analysing lithium stocks.

• Inventory turnover – Shows the rate a company sells and replaces its inventory over a period. A high ratio points to a strong sale, while a low ratio points to a weak sale.
• Net Profit Margin – Reveals how profitable an operation is. The higher the number, the better, and in cases where a business has higher margins than competitors, it can point towards a unique operational advantage that’s difficult to replicate.
• Price-to-Earning Ratio (P/E) – This measures the ratio of a company’s share price to its earnings per share. The P/E ratio helps the investor to know when a company is undervalued or overvalued relative to its peers. 
• Return On Equity (ROE) – Measures how well a company manages the investor’s money and generates value from it.
• Debt-to-Asset Ratio – Since lithium stocks often have to contend with high operating costs, many of these businesses turn towards debt financing. This ratio provides a useful gauge for investors to determine whether a business is over-leveraged.

Key Terms when Investing in Lithium stocks

This industry contains quite a bit of jargon that’s not often explained. With that in mind, here are some crucial terminologies investors ought to know before investing in lithium stocks.

• Battery Electric Vehicle (BEV) – An electric car that is powered by an onboard rechargeable battery.
• Lithium hydroxide (LiOH) – LiOH is used to produce cathode material for Li-ion EV batteries. It’s considered to provide the best energy balance.
• Lithium Oxide – A white solid used as a flux in ceramic glazes. It reacts with water and steam to form lithium hydroxide. 
• Electrolyte – Electrolyte is a medium containing ions and improves electrical conductivity. Lithium ion uses liquid electrolytes that enable movement between anode and cathode and stabilise their surfaces. It helps to improve cell performance and extend battery lifespan.
• Recycling – this is the process of converting used batteries that have been condemned to manufacture new batteries.

What is the Market Size?

According to a publication by Fortune Business Insight, the lithium market reached $3.83bn in 2020 and is projected to reach $6.62bn by 2028 at a compounded annual growth rate of 8.1%. Once again, this growth is primarily driven by the rise of the electric vehicle industry.

The processing and mining of lithium could be difficult in the future. Consequently, the lithium ion battery recycling market is expanding at an accelerating pace. So it’s not surprising that another report by Fortune Business Insights project this part of the industry to reach $6.55bn by 2028 versus $1.7bn in 2020.

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Top Lithium Stocks in the UK by Market Capitalisation

Top Lithium Stocks in the US by Market Capitalisation

Should I Invest in Lithium Shares?

As the push towards meeting the Paris Climate Agreement draws nearer, the adoption of electric vehicles is expected to accelerate. But this acceleration is already starting to cause supply problems which may result in businesses looking elsewhere for alternative energy solutions.

Pairing that with the capital-intensive nature of operating in this sector makes investing even in the best lithium stocks quite risky and unsuitable for everyone. Personally, I feel this is a risk worth taking. That’s why I am considering opening a few positions within this sector to diversify my portfolio.

Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has published a premium report on Tesla. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.