I'm Buying This Disruptive Innovator

Last week I introduced five companies I was considering adding to my Roth IRA. Today I'm letting you know which one I'm picking and why.

But to help you better understand how I went about choosing my winner for this month, I want to introduce you to a graph that could supercharge your own portfolio. Below, I'll explain how disruptive innovators work, and at the end I'll offer you access to a special free report on three companies our analysts think will help you retire rich.

Source: Author, based on The Innovator's Dilemma by Clayton Christensen.

The graph above is my own visual representation of an idea I learned about in Clayton Christensen's The Innovator's Dilemma, which shows how new products designed by relatively small companies eventually usurp standard products designed by large corporations. Of equal importance, disruptive technology generally becomes cheaper as time goes on, while standard technology usually maintains steady price points.

Typewriter, meet desktop
For a simplistic example, consider the typewriter (blue line) and the desktop computer (red line). Back in the 1960s, the typewriter was far more practical for the average office worker. Computers were enormous, expensive, and unwieldy for the average person to use. Its size, cost, and ease of use made the typewriter the obvious choice for businesses.

But fast-forward to today, and the story has changed. The desktop computer, with its dizzying array of executable functions, is now the slam-dunk choice. Over time, its ease of use, size, and price all became much more attractive.

An investment in the right computer firm in the 1960s would have been wildly successful. But it's important to note that not every disruptive innovator has the ability to make it all the way through the graph. Competition and acquisition can play huge roles in thwarting the innovative company, as can the possibility of being disrupted by yet another innovator.

I want to buy a company that is at the intersection of the blue and red lines. Though it may not yield sky-high returns over the long run, by focusing on a company whose technology is starting to outshine the competition, I think I'll be getting a safer bet with outsize returns.

The process of elimination
Of my choices from last week, I can eliminate Westport Innovations (Nasdaq: WPRT  ) and Solazyme (Nasdaq: SZYM  ) right off the bat. Westport is surely an innovative company, pioneering the design of tomorrow's natural-gas engines. But if you think about it, it doesn't exactly match the disruptive archetype. Yes, its engines are new on the scene -- and they'll likely improve over time -- but it's not the technology alone that gives the company so much potential. The availability of cheap natural gas plays a huge role as well. Take that variable away, and Westport would be in trouble.

With Solazyme, which can make tailored oils from patented microalgae, it's much the same story. The company is certainly innovative -- and it will likely continue to tweak its algae -- but it doesn't fit the archetype. The key for this company is not necessarily out-innovating traditional oil companies, but simply scaling up production so that its oils become cheaper.

Two that just missed the cut
When it comes to 3-D printing, the technology isn't quite at the point of utility I'd like to see quite yet. Without a doubt, Stratasys (Nasdaq: SSYS  ) and 3D Systems (NYSE: DDD  ) are both high-quality companies that could produce monster returns for shareholders.

But the companies aren't quite at the stage of adoption or utility where I can see them replacing the standard manufacturing infrastructure we have in place today. If my criteria for this search were different, or if we could fast-forward 10 years into the future, either of these companies would be the perfect choice.

My pick for the month
That leaves us with my pick for the month: IPG Photonics (Nasdaq: IPGP  ) . The company is a vertically integrated manufacturer of fiber-optic lasers. These lasers are most popular in the welding of large sheets of metal for industrial purposes, but they are gaining headway in other industries as well.

As opposed to standard carbon-based lasers (the blue line), fiber-optic lasers have been making huge leaps in strength over the past few decades. IPG's lasers are typically far less costly for its customers as well, both in their asking price and the amount of energy necessary to run them.

I see IPG's lasers standing at the intersection of the blue and red lines on my graph, and I see no reason to believe the company won't dominate its field in the decade to come. Surely economic slowdowns will hurt the company, as they will any company that relies heavily on industrial customers. But with every cycle, I believe IPG will gain more and more market share.

Worried about retirement
Obviously, I think having a disruptive innovator in my retirement portfolio is a good idea. But as I said above, not every potential innovator reaches the big league. It's important to balance your portfolio with both small up-and-comers and mature, established businesses with wide moats protecting them.

We've created a special free report on such companies: "3 Stocks That Will Help You Retire Rich." Inside, you'll get the names and details of three companies we believe deserve consideration in any investor's portfolio. Get your copy of the report today, absolutely free!

Fool contributor Brian Stoffel owns shares of all the companies mentioned except for 3D Systems. You can follow him on Twitter, where he goes by TMFStoffel.

The Motley Fool owns shares of Solazyme, 3D Systems, Westport Innovations, and IPG Photonics. Motley Fool newsletter services have recommended buying shares of 3D Systems, Westport Innovations, Stratasys, and IPG Photonics. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (6) | Recommend This Article (34)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 03, 2012, at 3:47 AM, Cake123xyz wrote:

    Did you really choose the best company out there in terms of being a real disruptive innovator? According to this article that appears to have been made in response to yours, I tend to believe you might need to do a little bit more research:

    http://seekingalpha.com/article/550111-biofuels-no-solazyme-...

  • Report this Comment On May 03, 2012, at 9:54 AM, bobc06385 wrote:

    i just bought ddd the fools recommended list.... and now watching it go down....

  • Report this Comment On May 03, 2012, at 12:19 PM, seattle1115 wrote:

    Keep an eye on Solazyme's patent portfolio. The company has been extremely aggressive in filing patents that have the potential to create a monopoly position in a number of different disruptive technologies. Ultimately, I think that production capacity might be irrelevant to the company's principle revenue stream going forward - I see a significant likelihood that, ultimately, the company may look to licensing, rather than production, for the majority of its earnings.

  • Report this Comment On May 03, 2012, at 12:39 PM, natgas2012 wrote:

    @seattle-

    If that's the case, it would be a very interesting shift for the company.

    @cake-

    I read the article, it's very informative, but I think the comment he took was out of context. In terms of what Clayton Christensen calls a "disruptive innovator", SZYM's oils aren't that--unless they're mysteriously becoming more and more potent as time goes on.

    Brian Stoffel

  • Report this Comment On May 03, 2012, at 12:42 PM, TMFCheesehead wrote:

    Sorry, that previous comment came from a profile I'm using to set up a mock portfolio. I should have used this username.

    Brian Stoffel

  • Report this Comment On May 07, 2012, at 5:15 AM, Cake123xyz wrote:

    Hi Brian,

    Are you suggesting that food oils that significantly reduce calories, cholesterol, and fat, while adding protein and fiber without sacrificing taste and mouthfeel fail to qualify as potentially being disruptive?

    What if it could also be used in practically every food application? What if it was also gluten-free, allergenic-free, and organic?

    What if this was just one current application of the company's oils being used and currently finding protection under dozens of patent applications?

    Don't you think you may be coming to your conclusions a bit prematurely without proper justification for your basis?

    -Cake123xyz

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