There are really only two types of companies out there: the disrupters and the disrupted.
Which resides in your portfolio?
It's not an easy question to answer. Everyone likes to think that their stocks are the lions feasting on the gazelles. They can't even begin to fathom that the speedy gazelles may turn the tables and gnawing on the overconfident lions. That 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.
How relevant will the companies in which you invest 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 actually approaching your own stocks objectively. Investors are primarily optimists, so the art of detachment, and pondering the worst-case scenario, is not entirely natural.
Do it, though. You want to make money -- perhaps a whole lot of money -- in this market, don't you?
Let me cut to the jugular. You may very well own Microsoft (Nasdaq: MSFT ) . It's the world's largest software company, readying the rollout of the promising Windows 7 operating system next month. Office 2010 is also on the way, as the undisputed productivity-suite champion. Microsoft's Bing search engine is also turning heads.
Now, can you honestly explain to me how the software giant will be as relevant in 2012 as it is in 2009?
The cloud-computing revolution is real, with Google (Nasdaq: GOOG ) and other companies offering free Web-based spreadsheets and word-processing programs that will eat into Office 2010's popularity. As more programs become browser-based, operating systems will become less relevant -- dealing a blow to Microsoft's Windows juggernaut.
So how confident should you be buying into a company with an awesome past, a decent present, but a cloudy future? If I were you, I would seek out the companies that will be more relevant in future.
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 everyone was buying their denim and khaki at Gap (NYSE: GPS ) ? Speedier AOL alternatives and hipper mall chains 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:
- Axsys Technologies (Nasdaq: AXYS ) is raising the stakes in the surveillance market with its high-performance cameras.
- China Finance Online (Nasdaq: JRJC ) is providing investment research to neophyte Chinese investors.
- AeroVironment (Nasdaq: AVAV ) is making waves in the military with its unmanned aircraft vehicles, sparing lives in recon missions.
- NetScout (Nasdaq: NTCT ) is the niche leader in helping companies monitor uptime for high-speed networks, something that will be even more important as more transactions go online.
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 -- China Finance Online and AeroVironment -- 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, Microsoft. 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. That's less than three years, but it's a great start!
This article was first published 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, except for NetScout. Google, China Finance Online, and AeroVironment are Motley Fool Rule Breakers selections. Microsoft is a Motley Fool Inside Value pick. The Fool has a disclosure policy.