Pick-and-Shovel Play: Overview, Pros and Cons, Examples

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.

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.

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.

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.

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.