Picks and Shovels

The picks and shovels theory is gold. Literally.

It’s about 150 years old and responsible for creating many fortunes, large and small. The problem is this market darling more often looks like an ugly duckling. Investors tend to go for something that’s a bit better on the eye.

The picks and shovels theory originated from the gold rushes in the 1850’s when scores of men and women flocked to the gold fields hoping to strike it rich. Some struck it lucky but most went broke.

The people who made the biggest fortunes were those selling the picks and shovels. These clever entrepreneurs understood that a hungry crowd was more important than having the best restaurant.

Since then, many picks and shovels have drifted in and out of fashion however they have always stood the test of time.

Consider this…

The dot.com boom
During the dot.com boom in 1999 – 2000, there was a frenzy of investors looking for the next nugget of gold. Everyone wanted to know which was the next stock to go from 50 cents to $5.00, as many did.

However the smart money invested in the picks and shovels – Telstra. They understood that for all the dot.com stocks to operate, they had to plug into the Telstra network.

And when the dot.com bubble popped and most of these stocks disappeared, Telstra continued growing despite looking like an ugly duckling for many years.

So is Telstra a good buy at $5.40?
Right now Telstra is going through a share buy-back. I.e. Telstra is buying back their own shares from existing shareholders because they believe that is the best investment they can make with their own money.

Without getting bogged down in the complexities of the offer, Telstra is offering shareholders $4.86 per share. This equates to $5.40 per share (after tax credits are added back in and assuming the shares are held in super with a tax rate of 15%).

The share buy-back has helped push up the share price in recent months however at these levels I don’t think it is cheap enough to buy nor worth your while selling (assuming capital gains tax and brokerage).

The problem with selling Telstra is where do you invest your money?

Bank term deposits offer around 2.5 – 3% (before tax) while Telstra shares currently offer a fully franked dividend yield of 5.43% (after tax). Inside a pension account, this yield is closer to 7.5% tax free.

Sure the stock price will oscillate up and down and may even experience another correction.

And even if you believed the Telstra share price was about to drop 20%, by the time you pay capital gains tax, buy/sell costs plus gst, and assuming you pick the top and bottom of the market, you wouldn’t be much further in front anyway. So you may as well sit tight and collect the dividends.

Many pick and shovel investments lose their lustre over time, but that doesn’t matter, because they’re the ones still sitting on all the gold. The Telstra network is no different. It’s just in need of  a good polish.