When Blacksmiths made more money than Gold Miners

Gold was discovered in California 1848. As news spread to the rest of the United States, huge numbers of people rushed to the state to try their luck at making a fortune of a lifetime. Once they reached California, they set about buying digging equipment like pickaxes and shovels. (Mining at that time was highly primitive).

The initial prospectors discovered gold and their success attracted even more prospectors wanting a piece of the action. Eventually, there were so many people digging around the state that the amount of gold individual prospectors struck was meager. The riches had gotten fragmented due to the huge competition among people vying with each other.

However, two sets of people became very rich due to the Gold Rush. The blacksmiths who made the pickaxes and shovels found themselves unable to meet the demand from those out on the field. They prospered as a result of the seemingly never ending demand for their wares.

The other set of people who got rich were landowners who happened to have the good fortune of owning land around the sites of the mining. Their holdings skyrocketed in value, and created some great fortunes.

Applying this Idea in Modern Times
The reason for mentioning this story in this blog is that it holds a great lesson for investors. For example, the power sector is among the most promising sectors in the Indian markets today. However, competition is so great today, and the valuations of power companies are so high that investors may not really enjoy healthy returns. However, there are segments of the industry which may just provide better returns.

For example, while there are huge plans for setting up power plants in the country by the likes of Tata, Adani, Lanco, Reliance, etc, most of them will probably end up buying equipment from suppliers like BHEL. As is well known, BHEL's current order book is currently overflowing.

Further, as huge power capacity comes up, there will be demand for laying cables for transmitting and distributing this power. There are very few well known companies manufacturing cables. Finolex Cables & KEC International are among the better known names in cable manufacturing. Finolex trades at TTM P/E of < style="font-weight: bold;">Why this Strategy Works
Big investors with the ability to incur large capex are incurring expenditures to put up huge plants which will begin to generate revenues in 3, 4 or 5 years from now. Till then investors will have to be patient with their return expectations.

However, the "pickaxe" players like BHEL & Finolex will get their money upfront (or at least part of it) when they receive orders. These company use these upfront payments as working capital for their manufacturing operations, which helps them to reduce their borrowing.

Tata Power, Adani & Lanco - meanwhile - have to repeatedly visit their bankers and the capital markets to raise more and more money to spend on their capital expenditure. Eventually their plants will start to produce power, but by then the markets will begin to value them at lower multiples (which are typically associated with utility companies).

Value investors would be well advised to think of the blacksmith, the next time we go prospecting for Gold mines.