Pick And Shovel Play

Understanding Pick-and-Shovel Play: A Strategic Guide to Smart Investing

Key Takeaways

A pick-and-shovel play is an investment strategy focused on companies supplying necessary tools or services for producing industry goods, rather than investing in the end product.
This strategy reduces direct exposure to market volatility in the final product by investing in industry suppliers.
The concept traces back to the Gold Rush, where tool suppliers often profited more consistently than the gold miners themselves.
Pick-and-shovel plays can offer more stable cash flows but remain vulnerable to downturns in their supported industries.
Consider suppliers in emerging industries as a means to mitigate risk while capturing growth opportunities.

What Is a Pick-and-Shovel Play?

A pick-and-shovel play is an investment strategy that targets companies supplying essential tools or services within an industry, instead of investing directly in the industry's end products. This approach allows investors to benefit from high-growth sectors while reducing their exposure to the risks tied to a single product or brand. Understanding how pick-and-shovel investments work and the pros and cons of using this strategy can help you execute this strategy, so you can make better investment decisions.

Understanding Pick-and-Shovel Investment Strategies

A pick-and-shovel play is a strategy for investing that consists of buying stocks in the tools or services an industry uses to produce a product, instead of in the product itself. In other words, an investor might invest in a supplier to an industry instead of investing in the major product producers within the industry.

The strategy is named after the tools used to mine for gold during the California Gold Rush of the 1840s and 1850s. Prospectors needed to buy a pick and a shovel to be able to mine for gold. While there was no guarantee that a prospector would find gold, the companies that sold picks and shovels were earning revenue and thus were good investments.

Fast Fact

The pick-and-shovel play is based on the economics concept of derived demand. This is when the demand for a good or service results largely from the demand for a different, related, good or service.

Effective Approaches to Pick-and-Shovel Investments

Traditional pick-and-shovel plays include investors buying shares of companies that manufactured oil wells instead of investing in petroleum producers. Investors could also buy shares in companies that build factory machines instead of investing in the companies that use the machines to make the final product or finished good.

Investing in raw materials such as metal to be used in the manufacturing process or equipment is a pick and shovel play. If the supplier sells their product or input good to multiple companies and industries, investors can reduce their risk of a financial loss since they don't have to rely on the sales of one product producer. Pick and shovel investments can be more consistently profitable and not necessarily fluctuate with one industry's sales.

Modern pick-and-shovel plays are useful ways to make money in industries that are new or risky or too niche to attract major investors, but that require tools and input to produce the products or services they sell.

Pros and Cons of Pick-and-Shovel Investment Strategies

Pick-and-shovel plays can be advantageous for investors seeking to profit from a hot industry while keeping away from that industry directly, which may be quite volatile. While individual gold prospectors may strike it rich or simply strike out, the shovels and picks industry would see more steady and stable sales. Moreover, to keep with this example, the "shovel" company will likely also be selling to other users of its tools, such as to construction or gardening firms.

There are still risks with pick-and-shovel plays since the industries they supply would need to be experiencing growth in sales and revenue. For example, let's say an investor bought a company's stock that supplies drilling equipment to the oil industry and the economy's growth rate slowed. The price of oil would likely fall due to less demand leading to the oil-producing companies cutting back on oil production. As a result, the drilling equipment supplier would also see a drop in sales and revenue.

Pros and Cons of the Pick-and-Shovel Strategy

Pick-and-shovel plays tend to have more stable cash flows

They also may have more diversified cash flows

A hot sector can suddenly collapse, drying up demand

Technological progress in the "tools" can make "mining" more efficient, lowering its price

Real-World Examples of Pick-and-Shovel Investments

Batteries (Instead of Electric Cars)

The electric vehicle (EV) market has soared over the years as automobile manufacturers rush to capture part of the growing market. Investors can invest in car manufacturers to play the EV market, or they can buy one of the suppliers. A pick and shovel play would be Panasonic Corporation, which is a major supplier of EV batteries for auto companies. Panasonic has long been one of the suppliers for Tesla Inc., inking a new deal in 2021 to provide more efficient "beer can" batteries; and in February 2020, announced a joint venture with Toyota Motor Corporation to produce its EV batteries.1

GPUs (Instead of Cryptocurrencies)

Another example, and one which more closely resembles the Gold Rush days, is the case of investing in computer graphics cards (GPUs) companies, where these were used for cryptocurrency mining. Stocks of companies like Nvidia (NVDA) and AMD (AMD) saw a boost in their share prices as crypto miners bought GPUs in bulk, even as cryptocurrency prices saw a high degree of volatility.

How Do You Find a Pick-and-Shovel Business?

To find "picks" and "shovels" today, look for a growth industry and identify the underlying technologies, inputs, or tools needed to support that industry or have it succeed. Then find the stocks of companies in those supporting industries. For instance, in the early days of the internet, while dotcom stocks were hot, the companies building out the infrastructure (of the internet e.g., routers, switches, fiber optic cables, etc.) would have been the "picks".

What Are Pick-and-Shovel Stocks for 5G?

5G refers to the next generation of wireless telephony, providing fast and reliable internet to a range of mobile devices like phones and tablets. Key suppliers of infrastructure like antennas and transmitters would be one type of pick-and-shovel to look for. Another would be the 5G device makers or mobile service providers, although these would tend to be closer to the surface than the infrastructure providers.

What Are Pick-and-Shovel Stocks for the Cannabis Industry?

Medical and recreational marijuana has become a hot industry. Supporting infrastructure for this sector could include makers of growing equipment (e.g., grow lights, hydroponics, irrigation, fertilizer, etc.). Companies that operate in these businesses thus would be pick-and-shovel plays for the cannabis industry.

Bloomberg. "Panasonic Bets on Tesla ‘Beer Can’ Battery to Unlock $25,000 EVs."

Investing

Alternative Investments