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The Next Big Flop

The difference between "hope" and "hype" is what separates great investments from duds. As a former PR guy, I came to know the difference between the two. (Heck, I knew people who had to write some of each.)

Accordingly, I steer my portfolio well clear of firms whose castles in the sky are built with papier mache. How do you spot these firms? Here are the top 10 signs:

10. This week's announcement: The CEO has a new parking space.

9. The income statement includes a line item for publicity stunts.

8. The company's product plan was found in a discarded Cracker Jack box.

7. Management decides to host the holiday party online to "cut costs."

6. Every meeting ends with, "So, when can we get a press release out on that?"

5. The company's tagline: "Leveraging our synergies since 2002."

4. The CFO is a certified grand master at buzzword bingo.

3. Executive bonuses are tied to boosting the "price-to-press mentions ratio."

2. 100% of the company's total assets are intangible, and 99% of those are unused PowerPoint slides.

And the No. 1 sign that you've bought stock in a company built entirely on hype: Paper is counted as raw materials inventory.

Think that's unreal? It isn't. Just ask Kenny Boy Lay or his partner in crime, Jeffrey Skilling. Last week, both men were convicted of a massive fraud in leading barely-breathing Enron. But I believe the key to the deception was a business model built on hype. How else do you explain Lay's appearance on BusinessWeek's list of 1996's best managers? (Whoops.)

Fortunately, screening for hype isn't that difficult. All you need is to ask these three questions of every press release you read.

Question No. 1:Is there a happy customer?
The best press releases include happy customers. For example, when Tri-Vision International announced a licensing deal with Jiangsu Shinco Digital Technology, the release mentioned many other apparently happy customers, including Sony (NYSE: SNE  ) , Hitachi (NYSE: HIT  ) , and Philips Electronics (NYSE: PHG  ) .

Now, contrast that with CIGNA's (NYSE: CI  ) announcement that JD Power and Associates gave it high marks for its call center operations. Although that's pretty cool, an efficient call center hardly makes CIGNA great at customer service. And it doesn't help that no customers were quoted in the release.

Question No. 2: Is money changing hands?
Another good sign is when money is changing hands, like when Motley Fool Rule Breakers pick iRobot (Nasdaq: IRBT  ) issued a release that said more than 2 million Roomba vacuum cleaners have been sold. With most Roombas going for $150 or more a pop, that's at least $300 million in revenue. Nice.

Question No. 3: How innovative is the product?
Finally, it's great when a company takes an obvious step forward in expanding its business. Consider the press release from a Fidelity National Financial (NYSE: FNF  ) subsidiary that says the company has launched websites in Chinese, Spanish, and Vietnamese. That may sound like just a tweak, but it's probably shrewd since immigrants are highly motivated to become homeowners. Accordingly, they could account for a huge portion of mortgage and title insurance business in the coming years.

Find potential without the hype
Castles in the sky fall, and hype always dissipates. That's why, instead of investing in firms that claim to be the next Google, David Gardner and his Foolish band of analysts recommend firms that are establishing new rules that alter the economics of multibillion-dollar industries. These firms need no hype. They just go about generating outrageous sales growth and massive returns. In fact, four stocks in the Rule Breakers portfolio have already become multibaggers. Find out their names with an all-access pass to the service. It's free for 30 days, and there's no obligation to buy.

Remember: PR folks can easily spin tales of woe into tales of triumph. Don't be enchanted. Trust, but verify. In doing so you'll spare your portfolio overhyped losses and maybe, just maybe, catch the next great legitimate growth stock.

Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Fool profile. The Motley Fool has an ironclad disclosure policy.

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