One of the strategies some very successful investors use is identifying the ‘next big thing’ and then investing in shares that could benefit from it. Right now, many people think alternative energy sources could be a massive emerging business area. Lithium may have a role to play in that as it is a key component in batteries for things like electric vehicles. So, does it make sense for me to buy lithium shares for my portfolio in 2022?
Buying an industry versus buying a company
First I think it is helpful to understand that in an emerging industry, not all companies will be winners. In fact, often there are fewer winners in an emerging industry than an established one.
Once an industry is well-established and profitable, it often supports only a few large companies with proven business models. In the early days, though, there are often dozens or hundreds of companies hoping to stake a claim in the new industry. Many, or even most, may be doomed to failure. That was the story of railway mania in Victorian Britain. It was also the story of the dotcom crash in the US. It could yet turn out to be the story of lithium. Some huge winners could emerge. But there may be hundreds of losers, too.
So if I wanted to invest in lithium shares, I would focus on understanding what a particular company’s source of sustainable competitive advantage might be. For example, does it have exclusive rights to an attractive area in which it can mine lithium? Does it have proprietary technology or processes that can help differentiate its lithium from that of other producers?
Diversification and lithium shares
I would also apply the same principles I use when considering companies in other, more established areas of business. For example, compare Rio Tinto and Zinnwald Lithium. Rio is a huge, established miner. It is growing its lithium footprint and last year purchased a big project in Argentina. But for now at least, lithium is set to be a rounding error for Rio, which last year reported total revenues of around £33bn. By contrast, Zinnwald is focussed on a single lithium project in Germany. Last year it had no revenue.
If I just wanted exposure to lithium, Zinnwald might seem to offer me the better choice due to its sharper focus. But its risk profile is very different to Rio Tinto’s. If one project disappoints – which is common in mining – it may just be a blip in Rio’s accounts. For Zinnwald, it could possibly undermine the whole company’s existence.
My approach in 2022
I do see potential in lithium this year and beyond. I would consider buying lithium shares in 2022. But when making any decisions about whether to buy, I will apply the same investment principles I use when buying other shares for my portfolio.
As an investor, diversification is a critical tool I use to reduce my risk. New industries are inherently risky. Intense competition can push up costs as companies outbid each other for the same scarce equipment. But even in a new industry, I still seek to diversify my investments. If I do decide to buy lithium shares in 2022, I will not buy them in any company whose hopes are pinned on a single lithium mine.
Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
