Investing In Fads

By Matthew McCall AAA

Over the last decade, there have been a number of fads that could have made nimble investors large amounts of money. The key word here is "nimble".

Although fads are often confused with trends, they are actually quite distinct. Trends tend to persist over the long term and are generally based on fundamentals. Fads, on the other hand, are generally marked by temporary and excessive enthusiasm, which turns out to unsustainable. But for investors who know when to get in (and get out), fads can provide a portfolio boost. However, if investors get caught up in the hype, they're likely to suffer the crash to which nearly every fad succumbs.

High-Flying Fads
A great example of a fad is the company Crocs (Nasdaq:CROX), which went public on the Nasdaq in 2006 at just under $15 per share. The maker of rubber shoes enjoyed great success as the demand for ugly sandals expanded from a boater's or gardener's shoe to acceptable everyday footwear. Everyone from kids to grandmas was wearing the comfortable and eye-catching sandal.

The news flow was bullish from the time the stock began trading publicly, and it was not out of the question to have quarterly sales growing by triple digits. Just 20 months after going public in November, 2007, the stock hit an all-time high of $75. That same day, the company reported quarterly earnings after the bell that saw revenue increase by 130%. But, after making such a dramatic move higher, the revenue gain was not good enough for investors, and the stock fell the following day and never looked back on its way to a low of under $1 in November, 2008.

Another footwear company that saw its fad dissolve quickly is Heelys (Nasdaq:HLYS), the maker of the sneakers with built-in wheels. The fad was popular among kids, who would whip around the malls on their roller-skate shoes. If you took a long afternoon nap you may have missed the entire fad. The company went public in December, 2006, and raised $135 million, 20% more than it expected, as investors clamored for shares of the IPO. After a gain of more than 60% on the first day of trading, the stock got as high as $40 before trading below $6 one year later, and then dropped as low as $1.10 by early 2009.

A third fad that blew up during the technology bubble of 2000 is the "click and mortar" phenomenon, and the best example of the collapse of this online retail boom and bust is Pets.com. Do not try and find a ticker symbol for the company because it traded publicly for less than one year. In February, 2000, the company, better-known for its sock puppet of a dog, went public with an $82.5 million IPO. Nine months later, Pets.com collapsed. It was not the only dotcom fad to run its course. Think about two other big names that are no longer in business: online grocer Webvan.com and toy e-tailer eToys.com. (To learn more, see Why did dotcom companies crash so drastically?)

Without getting into the nitty-gritty details, there are plenty more fads that could be covered. The list includes nanotech, the homebuilding stocks in the early 2000s, and the defense sector after 9/11. (To read about some fads that persisted into viable businesses, see Consumer "Fads" That Haven't Faded.)

Predicting When to Buy and Sell a Fad
The key to making money on both a fad and a trend is the timing of the purchase. From an investment standpoint, the entry point is extremely important because a fad can move a stock from an unknown to a high-flyer in a short period of time.

Even more important is knowing when to sell because a fad can turn from cash to crash in no time at all. As with the example of Crocs, although the company's sales continued to grow at an amazing pace, Wall Street was already dissatisfied with great numbers - investors wanted mind-blowing results, and when the company failed to deliver, investors dropped the stock.

With Crocs, Heelys and Pets.com, the underlying common theme has been competition and management's failure to consider the next step after meeting initial goals. With Crocs, the competition came from generic rubber sandals that sold for half the price and looked almost identical. Heeley's was in a similar situation in that competitors were able to nearly duplicate the shoe.

For Pets.com, competition from the old brick and mortar stores contributed to its demise, but the company also mismanaged its new-found wealth. Instead of putting the cash back into the company to grow and build the balance sheet, the management at Pets.com decided to spend millions on quirky Super Bowl ads that failed to generate sales, and ultimately resulted in the company's bankruptcy. (For more, see The Madness Of Crowds.)

From Fad to Trend
So how can you tell that a current fad might become a more profitable long-term trend? Let's look at a few current examples.

The most likely current fad to turn into a sustainable trend may be emerging market investing. Even though stock markets in China, Brazil and India have skyrocketed the last 10 years, that is likely to be where the growth will come from in the future and stock returns should reflect that. There may be some bumps along the way, but long-term investors need to consider the macro view and the possibilities these emerging economies hold for investors in the future. (For more, see A BRIC Investors Wall Of Worry.)

One other fad that shows the potential to turn into a trend is high-end denim. This is an industry that continues to surprise. Even in the face of one of the 2007-2009 recession, many high-end denim companies continued to release strong financial results. Now that jeans are acceptable as semi-formal wear, the sky may be the limit.

That said, promising fads contrast to niche sectors that show signs of being a bubble that is ready to burst. If you want to look at one such example in retrospect, just consider the dotcom crash in 2000; although the internet was in no way a fad, investors' predilection for any and all dotcom stocks was in itself an unsustainable fad, especially when many of the early dotcom companies proved to have very suspect business models. (For more insight into this and other market crashes, check out the Market Crashes Tutorial.)

Conclusion
In the end, both fads and trends tend to begin in the same manner - with lots of hype around the new product. The key to determining which direction the company will take depends on the viability of the product and the willingness of the company to adapt to changing market demands. The majority of the time the end result will be a fad, and as long as investors realize this, there will be an opportunity to make money. The keys to success are research, attentiveness to the action of the company's stock and being honest with yourself about the product.

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