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...

When chemicals giant FMC spun off its lithium-producing subsidiary Livent (NYSE:LTHM) as a new IPO last month, this pure-play lithium stock opened at a price of $17 a share -- but quickly dropped. It would be nearly a month before Livent shareholders would see that share price again.

For the last four weeks, Livent stock has mostly bounced around in the $14 to $16 range. It only just returned to $17 a share on Friday. And yet, far from considering Livent stock a busted IPO, today the IPO's underwriters are coming out in force to encourage investors to buy the stock.

Lithium salt evaporation ponds

Image source: Getty Images.

Five thumbs up

Six separate banking concerns teamed up to bring the Livent IPO to life last month: Citigroup, Credit Suisse, Goldman Sachs, Merrill Lynch, Nomura, and Loop Capital. Every one of these bankers -- except for Loop -- initiated coverage of Livent today with the equivalent of a buy rating, as reported by TheFly.com.

Here's what they're saying:

  • Other analysts' concerns about the supply of lithium outrunning the demand for lithium -- and leading to a price crash -- are overdone. Livent has a "long run-way" for growth before that happens as new lithium production projects hit delays and bottlenecks, slowing growth in supply. (Merrill Lynch)
  • These concerns have led to a sell-off among lithium stocks, but this reaction, too, is "overdone" and Livent still has an attractive valuation. (Goldman Sachs)
  • "[E]lectric vehicle adoption" is on the rise, and with it, demand for lithium hydroxide for use in rechargeable car batteries. Livent controls 26% of this market. (Citigroup)
  • In fact, Livent has plans to nearly triple its production of lithium hydroxide. Its "established relationships with both battery manufacturers and OEMs" should give it an "advantageous" position in the lithium hydroxide market "through 2025." (Credit Suisse)
  • Livent boasts multiyear contracts with battery customers manufacturing both electric vehicles and energy storage systems. (Nomura)

Now, it's probably not surprising to learn that the same bankers who underwrote Livent's IPO are coming out today to say it's a good stock. It's a bit more curious to see that these analysts are almost unanimous in their assessment of Livent's value, announcing $20 price targets on their buy ratings. (The only analyst with a different price target is Goldman Sachs, which says it thinks Livent is worth $22 a share.)

Are they right about that?

Valuing Livent

As the company explains in its IPO prospectus, Livent has "more than 20 years of experience and partnerships with leading customers across the EV value chain." On the one hand, yes, Livent gets a lot of its money from just a few customers. "One customer accounted for approximately 14% of our total revenue" last year, for example, and "our ten largest customers accounted in the aggregate for approximately 45% ... of our total revenue," says the company. On the other hand, roughly 60% of Livent's production capacity is secured by long-term contracts with its customers, which tends to mitigate worries over both customers jumping ship, and prices getting hurt by increased production of lithium by competitors.

Meanwhile, high prices are doing wonders for Livent's profits today. Trailing-12-month net income at the company is just under $85 million -- up more than twice from last year's $42.2 million in net income. Analysts surveyed by S&P Global Market Intelligence predict profits will nearly double again to $1.87 per share through 2021.

Thus, while Livent stock currently costs about 28 times trailing earnings, its projected earnings growth rate over the next few years is about 24.5% -- not too far off from a rate that would imply fair value for the stock.

Caveats and quibbles

That being said, even with Livent trading back below its IPO price, I'm not 100% convinced that the stock is as obvious a buy as its underwriters insist. For one thing, in order to achieve the tripling in production that Credit Suisse predicts, Livent is having to spend heavily on capital investment. Elevated levels of capex (currently running twice as high as what the company spent as recently as 2016) are eating into cash from operations, with the result being that Livent's free cash flow is nowhere near as strong as its GAAP income statement implies.

Livent isn't actually free-cash-flow negative, mind you. It actually generated a bit more than $3 million in cash profit over the past year. But that's still just a bare fraction of the $85 million in net profits the company claims to have earned.

Before I take Wall Street's advice and invest in Livent, I'm going to want to see evidence the company can generate strong free cash flow after its ratchets back on capex -- and so far, this is proof Livent has failed to produce.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.