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How to Master the “Hype Cycle” for Maximum Profits

If you don’t have a clue about the Gartner Hype Cycle, you’re about to find out!

It’s one of the simplest, yet most powerful tools that you can use to pinpoint the next profit opportunities in technology stocks.

I’m talking about the market’s next 200% to 1,000% gainers.

It’s also a surefire way to avoid getting ensnared in the Hype Trap. That is, buying into a promising technology, which boasts endless potential – but only ends up delivering massive losses.

Today, I’m going to give you a down-and-dirty overview of how to put this tool to work for your portfolio. Right away.

So let’s get to it…

Don’t Believe the Hype

Every summer since 1995, top tech research firm, Gartner, has released its Hype Cycle Report.

Per its own billing, the “report assesses the maturity, business benefit and future direction of more than 1,900 technologies and trends.”

This year’s report focuses on 92 specific technology trends, including Big Data, the Internet of Things, in-memory computing and strategic business capabilities.

Put simply, the report separates the hype from the reality for every imaginable technology trend in existence.

Gartner’s aim? To help enterprises decide whether it’s time to adopt each respective technology.

But if enterprises use it to time their adoption, it stands to reason that we can use it, too. After all, the more companies that adopt a technology, the more sales and profits it leads to for the providers of that technology. And, ultimately, that leads to higher share prices.

Understandably, Garter charges a pretty penny to access its comprehensive insights each year.

But we don’t have to pay a dime.

The most critical information in the report can be boiled down to a single graphic. And thanks to Google (GOOG), we can view it for free by simply searching for “Gartner Hype Cycle for emerging technologies 2012.”

(God bless the internet! At least in this case.)

Take a look…

(Please note: Gartner was not in any way involved with the creation of this chart.)

As you can see, the graphic tracks the progress of a particular technology through five distinct phases…

  1. Technology Trigger: Consider this the “Adam and Eve” moment. It’s when the technology is essentially created and the first prototypes come onto the scene. At this point, though, most technologies remain stuck in the lab with no commercial applications available.
  2. Peak of Inflated Expectations: After the trigger, early adopters come along and initial products enter a validation phase. Any success stories prove a breeding ground for increased enthusiasm and interest. Some companies adopt the technologies, but many others take a “wait and see” approach.
  3. Trough of Disillusionment: This phase is characterized by increasing skepticism over the long-term prospects for the technology. During this period, companies work hard to improve their products and address key concerns from early adopters. In essence, this is the period when work begins on perfecting the technology for primetime.
  4. Slope of Enlightenment: As second- and third-generation products are introduced, more companies recognize the merit of the respective technology. Adoption increases, although the most conservative companies still wait.
  5. Plateau of Productivity: During this phase, mainstream adoption takes off. This is when the companies behind the technologies begin to enjoy steady, above-average and more predictable sales growth.

As investors, the Hype Cycle proves valuable because the nature of each phase helps us identify two distinct buying opportunities and one undeniable “Danger Zone.”

When to Buy… And When to Sell

The first buying opportunity materializes in the middle of Phase 1 up to the middle of Phase 2. The companies in this space tend to be emerging growth small-cap companies.

Translation: Higher risk, but higher reward.

The second buying opportunity materializes during Phase 4. The companies in this space tend to be small- and mid-cap first movers, with established sales. As a result, they’re able to reveal more about future growth as mainstream adoption takes off.

As for the Danger Zone phase, we want to avoid technologies when they reach the Peak of Inflated Expectations. Or, more simply, when the hype hits fever pitch levels.

Why? Because the massive hype undoubtedly precedes a nasty fall. If you have any doubt, ask early Facebook (FB) shareholders.

You’ll recall that the hype surrounding Facebook’s social networking platform hit a crescendo just as the company went public. And shares crumbled by 61% before all the hype dissipated and investors finally began focusing on the fundamentals and true profit potential of the company.

So What’s the Hype Cycle Telling Us Right Now?

In future columns, I’ll spend more time fleshing out the nuances of the Hype Cycle and providing more historical context to prove its accuracy. Like any indicator, it’s not 100% accurate. But it’s accurate often enough that we can’t ignore it.

Today, though, let’s end by focusing on two things: First, the technology trends that are ripe for investing. And second, which area is in the Danger Zone.

Attractive technology trends right now include: The Internet of Things, biometric authentication methods, Big Data and mobile payments, among others.

If you read our special report – The Seven Most Investable Technology Trends of 2013 – you’ll notice some overlap. Coincidence? Not a chance!

As for the trend to avoid, there’s one in a particularly precarious position – 3-D printing. It rests right at the top of the Peak of Inflated Expectations.

I know… I know… everyone and their mom are touting the technology. Hence, the reason for caution.

Stay tuned for next Wednesday’s broadcast when I’ll dig deeper into the 3-D printing trend. I’ll specifically address the risks of investing in the leading companies in the space, 3D Systems (DDD) and Stratasys (SSYS).

At the same time, I’ll share an offshoot of the 3-D printing trend that I’m convinced is a more compelling opportunity. According to the Hype Cycle, it’s nowhere close to the Danger Zone.

Bottom line: Don’t (ever) believe the hype. (Bet Public Enemy didn’t know their hip-hop anthem applied to investing, too.) Instead, rely on the Hype Cycle as an idea generator for potential tech investments to buy and avoid.

Ahead of the tape,

Louis Basenese