What Is a Pick-and-Shovel Play?
A pick-and-shovel play is an investment strategy that invests in the underlying technology needed to produce a good or service instead of in the final output. It is a way to invest in an industry without having to endure the risks of the market for the final product.
This investment strategy is named after the tools needed to take part in the California Gold Rush.
KEY TAKEAWAYS
- A pick-and-shovel play is an investment strategy consisting of buying shares of companies in the tools or services an industry uses to produce a product.
- It is an indirect investment strategy that seeks to profit from industries that support a hot sector.
- Its name harkens back to the 19th-century Gold Rush strategy of investing in picks and shovel providers rather than mining for gold one’s self.
- With a pick-and-shovel play, an investor might buy stock in a supplier to an industry instead of a company that produces the finished good.
- Although pick-and-shovel plays can help reduce risk for investors, if the industry that these companies supply struggles, so too will the supplier.
How a Pick-And-Shovel Play Works
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.
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.
Strategies for Pick-and-Shovel Plays
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.
Advantages and Disadvantages of Pick-and-Shovel Investing
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
Pros
- Pick-and-shovel plays tend to have more stable cash flows
- They also may have more diversified cash flows
Cons
- A hot sector can suddenly collapse, drying up demand
- Technological progress in the “tools” can make “mining” more efficient, lowering its price
Examples of Pick-and-Shovel Plays
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.
