The hype cycle is a visual representation of the maturity, market perception and adoption of new technologies, first popularised by research firm Gartner.
Typically, the market will overestimate the short-term potential of any new technology and it will underestimate its longer-term potential.
These hype cycles have been observed consistently through time.
Good examples include the 1999 to 2000 tech bubble, the 2013 to 2014 3D printing cycle and the 2017 to 2018 cryptocurrency cycle.
These hype cycles create volatile movements, both up and down, in the underlying stocks exposed to these technologies.
Therefore it is vital to navigate these hype cycles to drive consistent long-term returns within technology equity portfolios.
One of the most talked about hype cycle is the tech bubble of 1999 to 2000, when market expectations for internet-changing commerce and our social lives saw expectations rise significantly.
It was only with broadband/3G, smartphones and Software as a Service (SaaS) solutions that we saw the real impact of how the internet would change our lives.
It is possible to show the clear difference between the hype of any given technology and its adoption, on the chart below.
Figure 1: Navigating the hype cycle
Source: Janus Henderson Investors
The green line represents the hype cycle curve andthe purple line representsthe rate of adoption of an innovation over time. The team analyses each new technology in the context of this hype cycle prior to making investment decisions.
Navigating the hype cycle: experience required
What makes these hype cycles so important? It is all about the pace of change, which is in part enabled by Moore’s Law, which has shown that technology typically becomes cheaper, faster and smaller every 12 to 18 months.
Rapid innovation enables legacy technologies to be quickly replaced by next-generation solutions, with major implications for legacy technology providers.
At the same time, they provide significant opportunities for next-generation players. It is the market’s expectations for these next-generation providers that typically become over-hyped, certainly in the short term.
The mismatch between hype and adoption provides both investment opportunities and risks.
Left and right split
We typically split this hype cycle into two parts; the left hand side, where most of the volatility and risk lies and the right hand side, where adoption typically runs ahead of the hype.
3D printing technology is a perfect example of the left hand side of the hype cycle. Looking back to 2013/14, the soaring stock prices of both 3D Systems (DDD US) and Stratasys (SSYS US) implied there were expectations that 3D printing was going to fundamentally change manufacturing and that most households could potentially own a 3D printer.
While the stock prices rose rapidly, they also fell equally rapidly as it became clear that while this was a very interesting technology, in the short term it was most suited for prototyping and small batch manufacturing.
It would not fundamentally change manufacturing just yet.
To put this into context in stock price terms, 3D Systems’ stock price rose from $10 at the start of 2012 to a peak of nearly $100 in January 2014 before falling back to $7 in January 2016.
Amazon is a great example of the right hand side of the hype cycle. Amazon was on the left hand side of the hype cycle back in 1999 and in early 2000 as the whole market was caught up in expectations for how the internet was going to transform our working and social lives.
The stock rose to more than $100 before falling to under $6 in September 2001.
Since then Amazon has been taking significant share in both retail and now also in public cloud infrastructure, with its Amazon Web Services offering.
This has seen Amazon’s share price rise from less than $6 to more than $1800 in under 20 years, highlighting the potential in the period when adoption is strongest for the company’s technologies.
Another example of a stock now on the right side of the hype cycle would be Software as a Service company, ServiceNow (Now US).
Back in 2013/14 overly bullish expectations for a broad range of the next generation of software stocks led to soaring share prices and valuations, including that of ServiceNow.
Falling by the wayside
Since then, many of those names that have fallen along the way including FireEye (FEYE US) as the outlook for these companies developed differently to expectations; this happened for a variety of reasons (including competitive positioning and changes to the addressable market).
Many of these stocks underperformed despite the software sector being an outperformer in this timeframe.
Through this period, ServiceNow has established itself as a genuine next-generation software platform, growing out from its IT service management base into a number of new growth areas (including IT operations management, security and human resources), this means that ServiceNow is now increasingly seen as a strategic vendor, helping its customers to automate processes and drive efficiency across their operations – this has enabled ServiceNow to exceed growth expectations.
The recent hype around cryptocurrencies, Bitcoin and Ethereum and in particular the various ICO (initial coin offerings) raising funding for new cryptocurrencies or digital tokens, is the closest to the fervour back in 1999/2000 and this remains an area we continue to avoid despite understanding the clear potential benefits to come from the underlying blockchain technology.
Our investment process focuses on navigating these hype cycles, understanding the growth potential of new technologies and identifying the barriers to entry that companies have built around their technology offerings.
Given the magnitude of price appreciations and price falls of many new tech stocks, it is particularly important to have an experienced team analysing these technologies and companies.
Graeme Clark is a fund manager on the Janus Henderson Global Technology fund
