The best lithium mining companies to invest in will meet key criteria, including operating in stable environments and having both sound balance sheets and realistic valuations

Lithium is used in household batteries, glass and ceramics, lubricants, refrigeration, pharmaceuticals, polymers and aluminum production. But the metal mostly goes into lithium-ion and lithium-metal batteries for electric and hybrid-electric cars.

Historically, lithium stocks have soared as investors start to believe that growing demand could lead to supply shortages. But you’ll need to look carefully at the fundamentals and prospects of each stock before investing.

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Background on lithium stocks

Spodumene is a hard rock that was once the most important lithium source. But most of today’s lithium comes from brine solutions drawn from salt lakes such as the Chabyer in Tibet and the Salar de Atacama in Chile. This is cheaper than producing lithium from spodumene, and the recovered metal is suitable for most uses.

However, when manufacturers need the purest lithium, they prefer spodumene because the final product has fewer contaminants.

Despite its range of expanding uses, longer term, lithium could fall victim to the oversupply issues that so often plague commodities when producers rush to catch up with rising orders. Lithium deposits that were previously deemed uneconomic to mine could be accelerated into production and that would bring prices back down.

Lithium mining companies to invest in operate in secure and stable regions

We generally stay away from mining stocks operating in insecure and politically unstable regions like the Congo and Venezuela, or in countries with little respect for property rights and the rule of law, like Russia or Mongolia.

Mining is inherently a politically vulnerable business; you can’t move the mine to another country, and local citizens sometimes believe that a foreign mining company is robbing them of their birthright, even though they probably need the foreign company’s capital and expertise to get any value out of the ground.

Lithium mining companies to invest in have strong balance sheets

We always analyze a company’s balance sheet before making recommendations.

A balance sheet is a financial statement that gives a snapshot of a company’s assets, liabilities and shareholders’ equity. Investors use this data to determine how sound a company’s finances are and also to discover if it has any “hidden assets.” Certain types of assets on a balance sheet might have actual market values well above historical values.

We look for well-financed mining stocks with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best lithium mining stocks all have sound balance sheets and reasonable debt.

Lithium mining companies to invest in do not have strict environmental constraints

We look at environmental constraints, too. In Australia, Europe, Canada and certain parts of the U.S, explorers need a particularly rich find to justify the costs of overcoming environmentalists’ objections. Some extraction and refining processes can be quite toxic, so you don’t see as much exploration and mining in countries with strict environmental laws.

Lithium mining companies to invest in will have a favourable market cap

We look at the market cap of mining stocks versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its reserves. We like a mining stock’s market cap to be no more than half the value of those reserves. We assume that the company will be able to expand its reserves with more exploration, but if the current reserves are double the mining stock’s market cap, it provides a margin of safety.

Note that resource and commodity stocks in general should make up only a limited portion of your portfolio. And as part of the resources segment, mining stocks could make up, say half of that total.

Should you invest in junior lithium mines?

Despite the strong potential of top junior mining stocks, it’s important to remember that these stocks are among the riskiest you can buy. That’s why we think it’s a mistake to load your portfolio up with these highly volatile companies.

Instead, make sure your investments are diversified by spreading your holdings out across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities).

However, junior mining stocks can play a role in a portion of your portfolio, specifically the part you devote to aggressive resource investments.

Use our three-part Successful Investor philosophy when making any investment decision:

1. Invest mainly in well-established companies
2. Spread your money out across most if not all of the five main economic sectors
3. Downplay or avoid stocks in the broker/media limelight

How well will demand for lithium hold up if other rare earth metals are adapted for use in electric car batteries?