Energy has been in the headlines more and more in recent years. That is why some investors reckon they might be able to do well by investing in emerging energy themes such as hydrogen and lithium. If I wanted to try and profit from buying lithium shares, here is how I would go about it.
Learn all about lithium
Famous investor Warren Buffett knows all about the energy industry. Across decades, he has invested in many power generators and network operators.
But Buffett also emphasises the importance of investors staying inside their circle of competence. Many investors know little or nothing about lithium and its possible future role. But just because something is not inside my circle of competence now does not mean that it will not be in the future. Yet for that to happen, I would need to learn about it.
So, if I was interested in investing in lithium shares, I would spend time getting to know much more about lithium’s possible future role in meeting global energy needs.
Figure out the value chain
Every industry has a ‘value chain’. Take gas as an example. A company like BP extracts it from the ground. Others like Diversified Energy may also extract it, but without the upfront exploration costs of BP. It gets transported along pipelines owned by a company like National Grid, traded by firms including Centrica and sold by companies such as DCC.
At each stage of the value chain, demand, costs and potential profits may vary. For example, BP may need to spend a fortune on exploration – but a big strike could be worth billions of pounds. National Grid may be less affected by price swings than a producer, as gas still needs to move through the network. That helps keep revenues stable. But National Grid may not see the same sort of profit uplift from a surging gas price as BP or Diversified Energy.
The same is true for lithium. If it becomes an important component in the energy space, what part of the lithium value chain seems most likely to profit? Would it be an early stage explorer? Will it be a company consolidating multiple mines across different locations, such as Ganfeng Lithium? Will it be a mine developer adopting a royalties-based business model like Trident Royalties? Could it be a battery producer, such as Tesla?
In a new industry, even if it ends up being profitable, those profits are often unevenly distributed. For me, a mining operator with only a single mine or lacking operational control over the mines from which it earns money is too risky. So my own investment focus would be on companies with a diversified portfolio of lithium mines.
Lithium shares and valuation
Even then, I would probably need to be patient. It will take time for the lithium industry to mature. During that process I expect many companies to stumble or fail altogether – including miners.
To manage my risk comfortably, I would focus on sizeable miners with both mining and commercial expertise and proven lithium deposits across multiple sites. I would consider adding such lithium shares to my portfolio – but only at an attractive valuation. If I pay too much even for a good business, it could turn out to be a bad investment for me.
