Don't Get Burned by Buzz

The power of buzz
I'm always amazed at the way the popular media latch on to certain products or companies. When a firm becomes a media darling, it makes for some of the most interesting (by which I mean "odd") commentary in the news.

One recent example is Google's (NASDAQ:GOOG) failure to beat Yahoo! (NASDAQ:YHOO) in the Web-answer service. While a few schadenfruede-ists out there have pointed out that this is proof Google doesn't always win, I'm more amazed at the apologists. Even in our own pages, Google's failure is redefined as success. Google fans look at the flop and admire the attempt. They hail it as a sign of healthy innovation. (For the record, I don't think this is any big deal for Google's business. I'm merely interested in the reaction.)

Now, imagine a media whipping boy -- say, Microsoft (NASDAQ:MSFT) -- failing at a similar initiative. The press would be pillorying Redmond and calling the failure a sign of a moribund dinosaur that lacks innovation.

Buzz and bad data
If you think that's an exaggeration, you need only turn to the press coverage of the Zune media player for proof of how bad buzz can be. Over the past couple of weeks, I've seen dozens (more likely, hundreds) of stories about how the Zune is a complete failure -- with the proof being "evidence" of lackluster sales. A startling number of these reports were based on pretty flimsy numbers, like a reference to Amazon.com's top sellers list.

Now, it turns out this buzz is probably completely wrong. According to some market research, the Zune in fact sold just fine, taking the No. 2 spot from SanDisk (NASDAQ:SNDK) in its first week out.

Bad buzz can burn you
Let's get back to the point, which is not "Zune rocks," but "buzz is for duds." Remember: Widely circulated media reports can be completely ill-informed and totally biased, meaning that the buzz about a firm's success and innovation -- or lack thereof -- can be 180 degrees off from reality.

Look back at SanDisk. When it first got into the MP3 market, it got a similarly chilly reception from the press. But it sold a surprising number of players -- and a lot more memory products than predicted -- and in late 2005, boosted by those revenues and profits, the stock ran from $50 to $75 in a few short weeks. In other words, if you'd listened to the buzz out there (as I didn't), you'd have sat out an opportunity for a quick 50% gain.

Bad to worse
Buzz can not only burn you by encouraging you to swallow bad data, but it can also force you to pay a premium price. This is what happens when a company benefits from too much love in the press.

When a company is praised to the sky for everything it does -- including stuff that won't make it any money -- the herds want in on the stock, and that pushes up the price. This is certainly the case with Google and other fashionable stocks, such as Crocs. And for those who claim these prices are cheap based on the current growth trajectories, I refer you to the results for previous buzz darlings like Microsoft, or Cisco Systems (NASDAQ:CSCO), or Dell (NASDAQ:DELL), from the year 2000 until now.

These "can't-miss" companies didn't necessarily miss in a business sense, but they never really lived up to the insane expectations built into the stock prices back when they were beneficiaries of the biggest buzz. The result? Near-50% losses over the past seven years.

It's natural to want to invest based on what the headlines are shouting at us, but history shows that investors are usually late to the game by the time the buzz is loudest. And it also shows that there can be huge potential for stocks with prices overly punished by a large dose of bad buzz. Apple Computer (NASDAQ:AAPL), for instance, was given up for dead by early 2001, but it has returned more than 1,000% since then.

Foolish bottom line
So what should you do about buzz? The simple answer: Use it for ideas, and nothing more. Don't believe the happy hype unless it's backed by real numbers. And always take a look at the companies the media loves to hate, because that's where you'll often find the best bargains.

In fact, betting against bad buzz is one of the key strategies of one of our top teams here at The Motley Fool. Every month, advisor Philip Durell and his merry band look at the real value being created by dozens of companies and put a price tag on what that company is worth. Then he demands a healthy discount (20% or more) to that estimate.

Some people might call that cheapskatery. We prefer the term "value investing." If you'd like to see how Motley Fool Inside Value is beating the market by betting against the bad buzz surrounding powerful cash generators such as Microsoft and Dell, a free trial is just a click away.

Seth Jayson has been around long enough to know that value investors are not born but made -- and usually, they're made out of reformed growth-chasers. At the time of publication, he was long Microsoft common and calls but had no positions in any other firm mentioned. View his stock holdings and Fool profile here. Microsoft and Dell are Motley Fool Inside Value recommendations. Amazon, Dell, and Yahoo! are Stock Advisor recommendations. Fool rules are here.