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. It is named after the tools needed to take part in the California Gold Rush.
Understanding Pick-And-Shovel Play
A pick-and-shovel play is a strategy for investing in an industry the investor thinks may be overvalued. If the industry is overvalued, it is either producing too much for the market to consume, experiencing escalating stock prices without corresponding earnings or coasting on reputation or enthusiasm without strong revenues or a building market. If producers in an industry are overvalued, an investor who wants to make money in an industry with lower risk can choose a pick-and-shovel play. This strategy consists of buying stock in the tools or services an industry uses to produce output, instead of in the output itself.
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 making money and thus were good investments.
Examples of Pick-and-Shovel Plays
Traditional pick-and-shovel plays included investors buying shares of companies that manufactured oil wells instead of investing in petroleum producers, buying shares in companies that build factory machines instead of investing in the companies that use these machines to make metal pieces and investing in farm machinery companies instead of investing in agricultural businesses. The strategy focused on investing in manufacturers that made the physical machines that were then used to make the output sold in the industry. These investments were more consistent and didn't fluctuate immediately with industry 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. One example is cryptocurrency. Cryptocurrency itself is not sold on major exchanges and is seen as way too risky for many investors, but the platforms used to host and trade cryptocurrency are a solid investment without the possibility of growth of the actual cryptocurrency but also without the risk. Buying shares in the companies that create these platforms is a way to get value from the industry without exposing themselves to the risk of investing in a new and non-traditional investment.