By Adam J. Crawford, Research Analyst
Getting in on the ground floor is the dream of all investors. Who hasn't wished they had bought Microsoft or Oracle back in the 1980s? And on the flip side, wouldn't it have been sweet to have seen the dot-com crash coming, in order to short the sector at its peak?
Of course. But is such strategic trading just a matter of dumb luck? Is throwing darts at the Nasdaq the best we can do? Or is there a mechanism that can help time the market?
Actually, there is such a mechanism, and while it certainly is not perfect, it does have significant predictive value. It's called the "Hype Cycle."
The hype cycle is a description of the various stages that a new technology goes through during its lifetime. Putting it to use can be highly profitable for tech investors, and in fact we have successfully employed it in selecting portfolio picks for both BIG TECH and Casey Extraordinarily Technology, albeit in different ways because of the publications' different goals.
The concept was developed at Gartner, Inc., the world's leading information-technology research and advisory firm. In 1994, Gartner consultant Jackie Fenn observed that there was a common pattern of development and adoption that new technologies always seemed to share. In the preface of her bookMastering the Hype Cycle, Ms. Fenn described that pattern as:
"... a rapid initial rush of enthusiasm for a technology's potential, followed by disillusionment in the face of real-world challenges, finally followed over time by a deeper understanding of what the technology could really achieve."
Fenn went on to elaborate:
"Some innovation comes along that captures people's fancy, and everybody, including the media, joins the parade with great fanfare and high expectations. This 'latest thing' always promises to bring fundamental change and great success for those who adopt it and great peril for those who don't. Then, when it fails to deliver the promised bounty right away, everyone starts bailing out. Cries of disappointment replace the earlier cries of hope and enthusiasm. The innovation that you ignore at your peril becomes a backpack of stones.
"There's usually more to the innovation than hype, hope and disappointment. It does contain something of lasting value. It's just that the value can't be found and extracted before disillusionment sets in. The truth is that innovations often need considerable experimentation and development, along with patience and tenacity, before they deliver anything worthwhile."
During that cycle, there are five key stages that technologies pass through:
- Technology trigger. An event, such as a product launch or product demonstration, creates sudden interest with the press.
- Peak of inflated expectations. Excitement and enthusiasm in the press and among technology leaders causes a bandwagon effect and results in unrealistic expectations.
- Trough of disillusionment. Impatience replaces enthusiasm as it becomes apparent that expectations for performance, adoption, and/or financial returns are not being met. The media now either focuses on unfavorable stories about the technology or abandons the topic altogether.
- Slope of enlightenment. Some businesses soldier on, working out problems, overcoming obstacles, and developing a deep understanding of how to best apply and benefit from the technology.
- Plateau of productivity. Real-world benefits are demonstrated and risks are lowered to acceptable levels. Adoption rates spike as the technology's value becomes apparent.
By way of illustration, Fenn drew a graph and populated it with some of the hottest technologies of January 1995, both emerging and mature. You can easily see how far along the curve the most successful tech has moved over the past 18 years, and decide for yourself which among today's innovations you'd place on the "Type A" bump.