You’ve probably heard of pick-and-shovel investing. The idea comes from the California Gold Rush of the mid-1800s.

Back then, the people who made the most money weren’t always the gold miners. Instead, it was those who were selling picks, shovels, and other tools to the miners. These businesses didn’t have to dig for gold or take big risks – they just supplied what everyone needed. One famous example is Levi Strauss, who built a fortune selling durable denim to miners.

In investing, the pick-and-shovel approach means backing the companies that supply tools and services to fast-growing industries – rather than investing directly in the companies leading the charge.

For example, instead of trying to pick the next breakout AI startup, a pick-and-shovel investor might look at companies that build data centers, manufacture semiconductors, or provide cloud services. These companies support the whole industry, so they often grow right alongside it – without the same level of risk.

They’re also in a great spot. As these industries grow, so does the need for their services. Sometimes, big players in the industry even buy them out, offering investors a chance for big returns.

Take Mellanox Technologies, for example.

This company might not be a household name, but it played a big role in the AI revolution. Founded in Israel in 1999, Mellanox made high-speed networking hardware – like Ethernet switches and other tools that help data move quickly between servers, graphics processing units (GPUs), and storage systems. That kind of technology is essential in modern data centers.

As Nvidia (Nasdaq: NVDA) became a leader in AI with its powerful GPUs, it ran into a challenge: Moving data between GPUs was slowing things down.

Mellanox had the solution.

Its networking tools helped GPUs communicate much faster – something that’s crucial for training large AI models. Nvidia saw how valuable this was and, in 2019, won a bidding war with Intel (Nasdaq: INTC) to buy Mellanox for $6.9 billion. The deal closed in April 2020, just as demand for AI and cloud services began to explode.

Mellanox is a classic example of a pick-and-shovel investment. Consider…

  • It didn’t compete with Nvidia – it made the firm better.
  • Its value grew as the AI trend took off.

Investors love these types of companies. As big trends like AI, cloud computing, or even cryptocurrency grow, the demand for supporting tools and infrastructure grows too.

Pick-and-shovel companies are often more stable, since they serve many customers across different industries. And because they’re so important, they’re often acquired at a premium price – just like Mellanox.

These companies might not make headlines, but they’re often behind some of the biggest shifts in tech.

— Kristin Orman

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