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A Pick and Shovel Strategy to Avoid Competition and Speculation

Instead of figuring out prospective stars in a booming space, look for their humble suppliers

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Feb 04, 2020
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Quite often, a sexy industry does not produce a sexy result for owners or shareholders, especially on a risk-adjusted basis.

Why? First of all, competition rules. Hot concepts easily attract capital. Think about the California gold rush in the late 1840s, where the discovery drew approximately 300,000 “forty-niners” (i.e. would-be gold miners) from the rest of the country and abroad. Too many miners chased limited resources. Within two years of the start of the rush, most of the easily accessible gold had already been collected.

Secondly, when a booming space is crowded with hot money, it becomes more speculative to look for the ultimate winner. Throughout the gold rush, it is estimated that more than half of the gold-seekers barely made any money or even wounded up losing money. While a few miners did score big, research shows that it was the merchants that made far more money. How? By selling supplies, including picks and shovels, to miners throughout the gold rush.

Fast forward to today, and we feel that the pick-and-shovel strategy remains relevant and effective to play a booming space that is filled with speculation and competition. Take a look at the biotech industry, which, despite a promising long-term prospect as a whole, is characterized by long development lead times (as much as a decade) and an overwhelming possibility of product failure (as high as 95% in terms of not reaching approval). Most investors struggle with predicting the long-term winner, if there is one to be found.

In this regard, a much safer bet could be the dominant suppliers to these biotech firms. No matter what drugs succeed or fail in the end, they earn money as long as the total industry is there.

Our favorite example here is Veeva Systems (

VEEV, Financial), the global leader of industry-specific, cloud-based software solutions for the life sciences industry. The company provides a broad spectrum of digital "pick-and-shovel" services that address the operating and regulatory challenges of drug makers. Per the latest filing, Veeva serves over 700 customers, including many of the largest global pharmaceutical and biotechnology companies like Eli Lilly (LLY, Financial), Novartis (NVS, Financial) and Gilead Sciences (GILD, Financial). Its platform and data are deeply embedded in the day-to-day operations and mission-critical processes of its customers, creating a high switching cost. According to the chart below, the business earned consistently high free cash returns on assets of above 15% for the recent years, outperforming its three customers listed above.


As another example of pick-and-shovel businesses, we would like to mention Manhattan Associates (

MANH, Financial) when it comes to the increasingly digital shopping experience. This company provides market-leading supply chain commerce solutions for retailers and brand owners that want to seize opportunities in the omnichannel and e-commerce space. Its customer base includes many of the world’s premier names, such as Adidas (XTER:ADS, Financial), Urban Outfitters (URBN, Financial) and Under Armour (UA, Financial) (UAA, Financial). Again, with a high switching cost of its installed base and a leading position in the market, Manhattan Associates (and its shareholders) should not care too much who is winning the retail war. In fiscal 2018, the business earned an over 40% free cash return on assets, which is far from reach among most retail companies today.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.

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