Picks and Shovels Play

A Picks and Shovels Play is an investment strategy that gets its name from the 19th-century gold rushes. Instead of betting on the fortune-seeking miners—many of whom went home empty-handed—this strategy focuses on investing in the companies that provide the essential tools, equipment, and services needed by the entire industry. During the California Gold Rush, the most consistent fortunes weren't made by panning for gold, but by selling picks, shovels, sturdy denim pants (hello, Levi Strauss!), and banking services to the prospectors. In today's market, this translates to identifying a major growth trend, like the rise of artificial intelligence, and investing not in one of the hundreds of competing AI startups, but in the companies that supply the critical infrastructure they all need. It’s a way to participate in the potential upside of an industry boom while aiming for a more diversified and potentially less speculative path to profit, a philosophy that resonates deeply with value investing.

So, why would an investor choose to sell the shovels instead of digging for gold? The logic is compelling, especially for those with a lower appetite for risk. The primary advantages are:

• Reduced Speculative Risk: Trying to pick the single winner in a hot new industry (the “gold miner”) is incredibly difficult. For every Amazon, there are thousands of failed e-commerce companies. A picks and shovels company, however, can succeed as long as the industry itself is growing, because it sells to all participants, winners and losers alike.
• Broader Industry Exposure: By investing in a key supplier, you are essentially betting on the growth of the entire sector, not the success of a single company. If the demand for electric vehicles (EVs) grows, the demand for lithium and batteries will grow, regardless of whether Tesla, Ford, or a new startup wins the market share battle.
• More Predictable Business Models: Suppliers often have more stable revenue streams. The fortune of a single biotech firm can hinge on one drug's clinical trial, but the company supplying lab equipment to the entire biotech industry has a much wider and more stable customer base.

Finding a great picks and shovels opportunity isn't about luck; it's about smart analysis. Here’s a simple framework:

1. 1. Identify the “Gold Rush”: Start by looking for powerful, long-term trends or “megatrends.” Think about major shifts in technology, demographics, or consumer behavior. Are we moving towards renewable energy? Is artificial intelligence becoming ubiquitous? Is an aging population increasing healthcare demand?
2. 2. Map the Supply Chain: Once you've identified a trend, think like a detective. What is absolutely essential for companies in this field to operate? Break down the industry’s value chain. For software companies, this might be cloud computing services. For EV manufacturers, it's batteries, semiconductors, and charging infrastructure.
3. 3. Find the “Toll Booth”: The best picks and shovels companies operate like a toll road; if you want to travel down the industry's highway, you have to pay them. Look for suppliers with a strong economic moat—a sustainable competitive advantage that protects their profits from competitors. This could be powerful patents, a dominant brand, high customer switching costs, or economies of scale that no one else can match.

Instead of trying to predict the next great AI application, consider the companies building the “brain” and “nervous system” of the entire AI ecosystem.

• The “Picks”: Graphics Processing Units (GPUs) are essential for training AI models. A company like Nvidia has a dominant position in this market.
• The “Shovels”: All advanced chips are made in highly specialized factories called foundries. Taiwan Semiconductor Manufacturing Company (TSMC) is the world's leading foundry, producing chips for countless tech giants.

The race for EV dominance is fierce, but all competitors need the same core ingredients.

• The “Picks”: Lithium is a critical component of modern batteries. Investing in a major lithium producer like Albemarle is a bet on the entire EV and battery storage market.
• The “Shovels”: EVs are useless without places to charge them. Companies building out public charging networks are providing an essential service for the entire industry.

Drug discovery is a high-stakes game with a low success rate. A smarter play can be to invest in the companies that enable the research.

• The “Picks”: Companies like Thermo Fisher Scientific provide the essential lab equipment, chemicals, and services that thousands of biotech firms and research institutions rely on daily.
• The “Shovels”: Many pharmaceutical companies outsource their research and clinical trials to specialized firms known as CROs (Contract Research Organizations), which provide the essential research and development services for the whole industry.

While the picks and shovels strategy can be a fantastic tool, it's not foolproof. Keep these risks in mind:

• Commoditization Risk: If a “shovel” is easy to make and has no unique advantage, fierce competition will erode profits. Always look for a company with a durable economic moat.
• Industry Decline: The fate of the shovel seller is still tied to the gold rush. If the entire industry proves to be a fad or enters a steep decline, the demand for its suppliers will evaporate too.
• Valuation Still Rules: Even the best company in the world can be a terrible investment if you pay too high a price. The principles of valuation are non-negotiable. A great picks and shovels business must be bought at a fair or, even better, a discounted price.