There are really only two types of companies out there: the disrupters and the disrupted.
What's in your portfolio?
We all like to think our stocks are the lions feasting on the gazelles. We can't even begin to fathom that the speedy gazelles may be the ones turning the tables and gnawing on the overly confident lions. Failing to take that possibility into account can be a costly mistake, because knowing the difference separates the market beaters from the blindsided and vanquished.
Thankfully, there's an easy exercise that will help you determine whether you're holding the prey or the hunter. I call it the three-year test.
Put simply, ask yourself this: How relevant will the companies behind your investments be in three years? If you can drum up an unbiased response, you will be able to sidestep losers today and load up on winners.
Take three steps back before going three years forward
The hardest step in this exercise is approaching your own stocks objectively. Investors are primarily optimists, so the art of detachment, along with pondering the worst-case scenario, is not entirely natural.
Make the effort, though. You want to make money -- perhaps a whole lot of money -- in this market, don't you?
Let me cut to the chase. You may very well own GameStop (NYSE: GME ) -- it's one of the rare retailers that thrived over the telltale holiday season. It's been posting healthy profit growth. Comps -- the feast-or-famine metric in the retail space -- have grown consistently higher. Now, can you honestly explain to me how the market leader in video-game retail will be as relevant in 2012 as it is in 2009?
Sure, the fundamentals appear sound today. The valuation is certainly attractive. However, this year alone we find the country's largest standalone toy store and the world's leading online retailer entering the used-game resale market. Used games make up GameStop's highest-margin business. You also have software developers such as Take-Two Interactive (Nasdaq: TTWO ) -- the company behind last year's best-selling video game -- ready to deliver premium installments of its Grand Theft Auto IV juggernaut directly to Xbox owners. In short, physical retail is being gradually replaced by digital delivery.
So how confident should you be buying into a company with an awesome past and a decent present -- but a cloudy future? If I were you, I would seek out the companies that will be more relevant in time. Clearly there will be bigger opportunities for the video-game developers and console manufacturers as they cut out the middlemen.
Dig for disruptors
Every company believes that no one else can build a better mousetrap. Shareholders know better. Disruptors always come along. Heck, even disruptors get disrupted. Remember when AOL owned online connectivity, and wheeled Heelys (Nasdaq: HLYS ) were the footwear of choice? Speedier AOL alternatives and a fashion shift away from bumps and bruises turned the hunters into the hunted.
If you want to beat the market, the first step is to stay ahead of the market. Where are the disruptors today? They're everywhere, if you know where to look. Here are four I'm eyeing:
- iRobot (Nasdaq: IRBT ) is revolutionizing the battlefield with its all-terrain recon and bomb-sniffing robots. It's also doing just fine closer to home, with its Roomba vacuum-cleaning automatons.
- First Solar (Nasdaq: FSLR ) is one of the leaders in transforming sun rays into solar energy. If you don't see this as a more popular energy form in the future, you need to get out more often.
- Akamai (Nasdaq: AKAM ) is the undisputed champ among content-delivery networks. Akamai helps speed up the secure delivery of media files, software updates, and Web pages.
- Sirius XM Radio (Nasdaq: SIRI ) appeared to be heading for Chapter 11 bankruptcy three months ago, but it's hard to ignore a growing leisure service with 19 million paying subscribers. It is padding its coast-to-coast satellite-radio coverage by beefing up its Internet radio offerings, which is where the technology is ultimately heading.
How did I come across these disruptors? Well, I'm one of the analysts on the Motley Fool Rule Breakers newsletter team. Two of these stocks -- Akamai and iRobot -- are active recommendations. Subscribers can also unearth superior growth stock ideas on the lively discussion boards, where members pick apart potential winners.
These are companies that I can see mattering a lot more in the future. They specialize in niche industries that can take down -- or revolutionize -- larger sectors. They pass my three-year test.
Sorry, GameStop. You flunked with fading colors.
Join me and my fellow subscribers in sniffing out the next wave of market-thumping disruptors. I invite you to check out Motley Fool Rule Breakers free for the next 30 days.
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This article was originally published on March 3, 2009. It has been updated.
Longtime Fool contributor Rick Munarriz is a fan of disruptive growth stocks and has been part of the Rule Breakers analyst team since its inception nearly five years ago. He does not own shares in any of the stocks in this story. Take-Two Interactive, Akamai, and iRobot are Motley Fool Rule Breakers selections. GameStop is a Stock Advisor pick. The Fool has a disclosure policy.