What Is 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. The investment strategy is named after the tools needed to take part in the California Gold Rush.
- A pick-and-shovel play is an investment strategy consisting of buying stock in the tools or services an industry uses to produce a product.
- 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 the company supplies 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 stock 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.
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-shovels 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.
Risks with Pick and Shovel Plays
However, 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 to cut back on oil production. As a result, the drilling equipment supplier would also see a drop in sales and revenue.
Real World Example of a Pick-and-Shovel Play
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. and as of February 2020, announced a joint venture with Toyota Motor Corporation to produce EV batteries.