Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Was it really just weeks ago that analysts were upgrading stocks like Albemarle (NYSE:ALB) and Sociedad Quimica y Minera (NYSE:SQM) on predictions of a deficit in lithium metal supplies for electric car batteries? (Hint: Yes, it was.)

But my, how times change! Less than one month after UBS upgraded Albemarle stock to buy, and not even three weeks after JPMorgan assigned a similar rating to SQM, the lithium stock rally came to a screeching halt when fellow investment banker Morgan Stanley begged to differ, downgrading both Albemarle and Sociedad Quimica y Minera to underweight.

Here's what you need to know.

Lithium collection and processing facility

Image source: Getty Images.

A bit of history

In recent months, investors have begun to worry that shares of Albemarle and SQM were both overheating. Rising prices for lithium and rising investor enthusiasm for lithium stocks were pulling more supply onto the market, and these two leading miners were rushing to capitalize on skyrocketing demand for a metal essential to the production of modern rechargeable batteries.

Cue concerns about oversupply.

Bulls on parade

By late 2017, worries that supply could soon swamp demand for lithium sapped strength from the lithium stocks' rally. But as Wall Street watched these stocks fall, bankers' interest was piqued. In January, UBS published a report admitting that there was a possibility "spot prices may decline," but insisting that long-term supply contracts would protect Albemarle from these declines. More importantly, said UBS, lithium demand should triple by 2025, easily eclipsing rising supplies and sustaining the uptrend in lithium prices.

It wasn't long before JPMorgan joined the chorus. The sell-off in lithium stocks had gone overboard, said JPMorgan. Supplies of lithium remained "tight," and while it was true that SQM was expanding production, this was a good thing. SQM would be selling more metal at higher prices, and making more profit as a result.

Bears rush in

Except maybe not. Joining the debate yesterday, investment banker Morgan Stanley proffered an alternative view of the lithium market.

UBS may believe that lithium demand will triple by 2025 as more electric cars carrying more lithium-ion batteries are sold. But Morgan Stanley points out that if 2% of car sales globally are for electrics currently, that number will need to rise to 31% for lithium demand to soak up the 500,000 tons of new lithium supply it expects will come on market by 2025. That's a required increase of not three times, but 15 times.

Granted, this is not an entirely apples-to-apples comparison. UBS' prediction of a threefold increase in demand referred to lithium being used for all sorts of batteries -- cellphones, laptops, cars, what-have-you. Morgan Stanley's estimate focuses on lithium demand only for electric car batteries. Still, it's a big difference in expectations. In marked contrast to what its banking peers are saying, Morgan Stanley predicts lithium "supply additions [will] swamp forecast demand growth" over the next seven years.

In fact, in Morgan Stanley's estimation, 2018 will be the last year lithium demand exceeds lithium supply (and therefore, the last year that lithium metal enjoys strong pricing power). By as early as 2019, "significant surpluses" of lithium supply will begin forcing down lithium prices -- and by 2021, Morgan Stanley expects to see lithium selling for as little as $7,332 per metric ton, down 45% from current prices of $13,375 a ton.

What it means to investors

And there you have it, folks: The reason SQM and Albemarle stocks plunged yesterday, and the reason they might continue falling for the next three years, assuming Morgan Stanley's pessimistic prediction proves to be the right one.

How should you respond to this latest development? It really depends on whom you believe. For the time being, at least, Morgan Stanley looks like an outlier in deriding the prospects for lithium price growth -- and lithium stocks' growth. According to data from S&P Global Market Intelligence, the consensus on Wall Street remains that Albemarle will continue benefiting from strong lithium prices and grow its earnings at better than 11% annually over the next five years, while SQM will do even better -- growing earnings more than 28% annually over the same period.

Responding to these predictions, investors are valuing Albemarle at 14 times earnings, and faster-growing SQM at 35 times earnings. If you ask me, these valuations don't look outrageous if UBS and JPMorgan are right about the future of the lithium market. But if Morgan Stanley turns out to be right -- look out below. Either of these two formerly red-hot stocks could prove too hot to hold.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.