When To 'Believe the Hype' of a New Product

by: Larry Bellehumeur

When it comes to "Hyping" a product, it is clear to most people that Apple (NASDAQ:AAPL) has no peers. Long before people knew the total functionality of an iPod, they knew that they had to have one. In my opinion, this was the most successful product launch in recent memory, and was only topped by their next product, the iPhone.

Companies do their best to ensure that Consumers (and, Investors) are aware of what is coming out. This helps their business in several ways. One, it provides a level of "excitement" for their company. Two, it helps to ensure that people know that they are on the "cutting edge". Three, it can help to deflect away from a current offering in market from one of their competitors. Finally, if done right, it can ensure that the product has a strong demand at the time of launch, ensuring a good success.

This begs a few questions:

  • Which Industries are most likely to "Hype" a product that has not been released?
  • At what stage should you "Buy into the Hype"?
  • How can an investor profit from all of this?

1) Which Industries are most likely to "Hype" a product that has not been released?

Among a list of the most likely Industries to hype a product, one might think of Entertainment, Consumer Discretionary and some parts of Consumer Staples market, Pharmaceutical, Technology and Automotive.

For Consumer-related products, it make sense to have a big splash, as you want to ensure that the public is well aware of what you are releasing, and what it can bring. This would hold true for Cars, MP3 players, movies and even disposable Razors (can't think of a better way to hype your product than Tiger Woods, right, Proctor and Gamble?)

For Big-Pharma and for larger Technology purchases, one would not expect that there would be such a need to drive up consumer demand. Sure, letting people know that there is a new drug for blocked arteries or a new add-on for your SAP system will create some demand, but this is not likely the main reason.

Big Pharma companies are usually marketing to Doctors and other areas of the Medical system, and not so much to the patients themselves. They need to be considered on the Cutting Edge of Health care, to maintain their stature in the minds of the Medical community. As well, much attention is being paid to the "Drug Pipeline" of Big Pharma by the analysts at Wall Street, so they need to ensure that news of how new medicines are progressing are well known, even if they are not coming out for several years.

In terms of Technology, pre-announcing new technology products or upgrades can serve a few purposes. First, it helps to protect brand loyalty, as people who are already your customers can feel comforted in knowing that you are advancing the product that they are using, and that they will be able to upgrade without having to install a brand new system. Next, one of the biggest fears about buying a Technology product, especially on a large scale, is that something better will come along before I finish rolling out. Companies who are savvy can play up this aspect to successfully disrupt the sales of their competitor's products that are currently in market. One has to be careful with this tactic, however, as it can unsettle customers to the point that they never make a decision.

Finally, like Pharma, Technology companies need have IT departments think of them as being on the "Bleeding Edge". By constantly announcing new products, you can appear to be ahead of your competitors.

2) At what stage should you "Buy into the Hype"?

Buying a company's stock based on what might come out can be a very lucrative, yet extremely risky proposition. The level of risk seems to be based on the following factors:

  • How "established" is the company?
  • How "buggy" have their products been at the time of launch on previous product launches?
  • How far in advance are they pre-announcing a product?
  • How far are they "pushing the envelope" with this new product?

First, most Start-up companies are looking for a way to get their product offering known. One of the easiest ways to do this is to announce an incredible finding or a product that pushes so far ahead of what is currently on the market. Don't get me wrong, some of these products do eventually come to market, and those who bought into the story early are generally extremely rewarded (just ask early shareholders of Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT) and Google (NASDAQ:GOOG)). However, more often than not, the average investor is better off staying out of these types of investments, unless it falls within an area of your expertise. If this is the case, it may be worth a small portion of your investments.

There is an old expression that you shouldn't buy a car in the first year of its production, as they likely haven't gotten the "kinks" out of it yet. For many years, this was probably extremely accurate, and it still may be somewhat accurate today. For this reason, Automotive is one area of the market that a smart investor might want to avoid some of the hype (As an exception to this rule, Hybrid and Electric car manufacturers may be a good place to look, even at the time of launch). Another one where people might want to be cautious is in the Corporate IT world, where large companies are showing some recent reluctance to invest in new technology upon its release, as there will inevitably be a few "Service Packs or Bug Fixes" over the first 6 months to fix glitches. The same issues do affect Consumer IT products, however, they do not ever seem to have the same impact on sales. This is evidenced by some of Apple's issues with the iPhone, but it doesn't seem to have hurt their sales very much.

Companies that announce that they have a new product coming out on the day of launch are likely taking a very conservative approach. While there are no assurances, it is likely that the product will have been thoroughly Market-tested, and should be ready to go. On the other hand, companies that announce a new drug or car that is coming out in 2013 may be a more risky adventure. Many things can happen in a 5-year period (Government regulation changes, Increased competition, Increased prices in Commodities or other inputs and more) to make this a more risky venture.

Finally, the riskier the product, the more likelihood for glory and for failure. As mentioned before, Gillette is announcing its new razor with great fanfare. Since they have been making razors for years, and since it is a fairly basic product, there is little risk in such a product failing. However, someone who is developing a Hydrogen fuel cell might have great technology and ideas, but is also just as likely to lose your entire investment.

3) How can an investor benefit from the "Hype"?

A) Invest in those companies who help other companies bring their products to market faster and cheaper

  • One such example is Pharmaceutical Product Development (NASDAQ:PPDI). Their main role is to assist Pharma companies in running the required trials for new medications. One caution is that this is not a pure play, as they also have some development efforts for new drugs of their own. Trading at just under 20x its forecasted 2009 earnings, this one is definitely not cheap, but it is expected to grow its earnings by about 20% annually over the next 5 years, making it fairly valued here.

B) Invest in those companies who supply parts or services for Hyped products

  • Companies whose products/services that have been chosen to be part of a new "hyped" product may also benefit (in the short-term, especially) from an uptick in earnings and visibility. This is especially true if this new business will make up a significant part of their overall revenue base.
  • In the iPod example, it is believed that the following companies were significant suppliers to Apple: Sony (NYSE:SNE) (Battery), Wolfson (OTC:WLFMF) [CODEC], Storage (Toshiba (OTCPK:TOSBF)), Firewire (Texas Instruments (NYSE:TXN)) and Power Management (Linear (NASDAQ:LLTC)).
  • While the overall impact of the iPod might not have been significant for Mega-Caps like Sony, Toshiba and Texas Instruments, it would have had more of an impact on Wolfson, a company with under $1B in revenue in 2007. **Please note that it is likely too late to get on the iPod suppliers "bandwagon", and this was only an example.

Other suppliers to look for include those who supply in to the following areas:

  • Green Technology products
  • Hydrid Vehicles
  • Aerospace
  • Infrastructure

One that looks promising is Precision Castparts (NYSE:PCP). This company supplies many specialty parts to Airplane manufacturers and to the manufacturers of Plane engines (GE (NYSE:GE) is one of their customers). Their components are quite specialized, so companies would be reluctant to switch to an alternative supplier.

The movement towards more fuel-efficient planes means that the usual turnover of planes may be accelerated. Combining this with the expected uptick in travel by Emerging markets means that there should be further demand for their products. Down about 35% from its 52-week high, this one is now trading at less than 13x 2009 earnings (fiscal year ends March 2009). With a strong RoE of over 25%, strong cash flow, and the ability to greatly raise its small dividend, this one looks like a good bet to soar.

C) Invest in the Retailer who might benefit from the uptick in Sales.

  • This point is especially true if the retailer sells products that are likely to be aimed at the 12-21 year old consumer.
  • The first example is book resellers. Whenever a new Harry Potter book would hit the shelves, there would be an incredible traffic spike to the stores (or, in the case of Amazon, to their web page). This not only resulted in higher sales directly from that book, but also from extra purchases from parents who were at the store, including high margin items such as Lattes. While this spike is almost for sure temporary, it would be a profitable time for those who followed this trend. Barnes and Noble (NYSE:BKS) and Amazon (NASDAQ:AMZN) are two ways to play this future trend.
  • The second would be the Electronics retailers, during a release of an extremely hot game, such as Halo III. The resulting game may also result in sales of other components, such as new PCs / Video Game Consoles and Accessories. While the impact might not have a huge impact on the bottom line for long, it will also drive huge volumes of people to the store. For those retailers who excel at Marketing and Customer service, this extra traffic could prove to be quite profitable if capitalized on correctly. I would stick with quality here, and the one that comes to mind is Best Buy (NYSE:BBY).

Disclosure: None