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What is pick and shovel investing, and how does it work?

06/10/2020

Every investor will have their own strategy when it comes to deciding how and where to invest their money. One approach that some opt for is pick and shovel investing – but what exactly does this strategy involve, and how does it work?

 

What is pick and shovel investing?

Put simply, pick and shovel investing involves investing in the companies that provide the services or tools needed to create a product, rather than in the companies that offer the final product itself. 

The strategy takes its name from the California Gold Rush of the 1840s to 1850s. Those planning on prospecting for gold needed to purchase both a pick and a shovel in their quest for wealth – and while it was not guaranteed that they would, quite literally, strike gold, it meant that the companies who produced and sold picks and shovels saw a rise in revenue and were, therefore, a good investment. 

 

Examples of pick and shovel plays

IG.com gives a number of examples of pick and shovel plays. These include: 

  • Oil and gas: Oilfield service companies that dig wells and build rigs; companies that operate oil pipelines, companies that ship oil and gas. 
  • Construction: Businesses that produce building materials like clay and concrete; firms that provide plumbing and heating services. 
  • Telecoms and mobile: Companies producing 5G chips; suppliers of equipment such as transceivers and antennae for 5G equipment.
  • Healthcare: Producers of laboratory equipment, surgical masks or glass vials. 

 

Is pick and shovel investing a good strategy?

While pick and shovel investing could potentially be a lower risk strategy than investing in the companies that create the end product or service, no investment is completely without risk. Investopedia points out that in order to secure a decent return, the industries that these companies supply would still need to be performing strongly. 

As an example, they describe how an investor could purchase stocks in a company that supplies drilling equipment for the oil industry. If the growth rate of the economy were to slow, a likely fall in demand would lead to a drop in oil prices, and a reduction in oil production. This would most likely result in a decline in both sales and revenue for the drilling equipment supplier.

In short, pick and shovel investing is a popular choice for some, but still involves investing in a single company, which is not without its risks. For this reason, it is always worth thoroughly researching all of your options before deciding which investment route to take. 

 

“Stable Rise Limited is not authorised or registered by the Financial Conduct Authority. The marketing materials are not intended to provide financial advice nor promote any individual financial products.”

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