Stocks leading the way in disruptive industries have historically produced outsized results. The long-term returns of stocks such as low-cost retailer Walmart and streaming giant Netflix show the powerful force that brings change and improvement to people's lives.
However, profiting from such opportunities often means finding companies early. While nobody can make guarantees about the future, Roku (ROKU 1.58%) and Upstart (UPST -1.25%) hold such potential, and investors can find a more diversified approach to disruption in the ARK Innovation ETF (ARKK -0.66%).
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1. Roku
Roku is best known for enabling streaming through devices or televisions that incorporate its technology. But these platforms primarily offer support for Roku. Rather, the company's investment case hinges on the revenue driver behind television: advertising.
The company leverages viewer interest to draw advertisers to its platform, a powerful play as customers transition away from broadcast and cable TV and instead move to the streaming side. By the end of 2021, Roku's ecosystem attracted 60 million users, making it the leading streaming platform in North America according to the streaming analytics website Conviva.
Image source: Roku
Roku's business model generated almost $2.8 billion in revenue in 2021, 55% more than in 2020. This also gave Roku a full-year profit of $242 million in 2021, a considerable improvement from the $18 million it lost in the prior year.
Despite the revenue increase, investors soured on the stock after management forecasted first-quarter revenue growth of 25%, a significant slowdown from 2021 levels. Moreover, supply chain constraints and intense competition outside of North America have rattled investors. The stock dropped nearly 80% after achieving an all-time high last summer.
Still, Roku's price-to-earnings (P/E) ratio is sitting just under 6, which is near a multi-year low for the company. For comparison, Roku traded at a high of 33 in early 2021. As the transition to streaming continues and Roku spearheads the future of television, Roku stockholders will likely benefit.
2. Upstart
Upstart wants to disrupt the longtime measure of creditworthiness: the FICO (FICO 0.05%) score. Its AI-powered tool analyzes more metrics, enabling Upstart to find loan opportunities that the FICO score might overlook. Because Upstart merely evaluates the loans for a fee, it does not take on loan risk directly.
The company began as an evaluator of personal loans. However, Upstart more recently entered the much larger auto loan market and plans to soon expand into evaluating mortgages and small-business loans.
Despite this potential, Upstart brings with it considerable risks. It has never faced a financial crisis or a rising rate environment. Additionally, more than half of its loans come from just one institution, Cross River Bank. Should Cross River Bank drop Upstart, it could devastate the stock.
Still, the numbers don't point to any dissatisfaction. For 2021, revenue came in at $849 million, and the 264% year-over-year growth rate indicates its popularity has risen dramatically. Adjusted net income came in at $224 million, a massive surge from the $17.5 million in net income reported in 2020. Keeping operating-expense growth to 219% allowed income to rise.
Nonetheless, the sell-off in tech stocks and the sector's subsequent volatility have spooked investors. Because of this, Upstart stock has fallen about 80% from its high. However, its P/E ratio has fallen below 60, a record low discount considering its triple-digit revenue growth.
The stock is not for the risk-averse. But if it can continue growth and weather crises, investors could earn outsize returns if they buy now.
3. ARK Innovation ETF
Those who want to invest in emerging industries without taking on the risks of individual stocks might consider outsourcing the job to a well-known cheerleader of disruptive innovation, Cathie Wood.
The CEO of ARK Funds has put together a portfolio that takes advantage of disruptive innovation and is diversified across many industries. Wood's ARK Innovation ETF is invested in 36 "disruptive innovator" stocks; seven of those stocks each account for more than 5% of the fund's holdings. Tesla (TSLA 4.96%), Teladoc Health (TDOC -2.91%), Zoom Video Communications (ZM -0.99%), and Roku are its four largest holdings.
Wood has also beaten Wall Street with some bold calls. In 2018, when Tesla traded at a split-adjusted $69 per share, she told CNBC it would reach $800. These days it sits at about $1,000 per share.Such predictions have benefited Wood's portfolio. Since the inception of the ARK Innovation ETF in 2014, the fund has delivered a total return of about 215%, well above the S&P 500's 150% gain over that same time frame. These impressive returns factor in a 55% decline from the ARK Innovation ETF's 52-week high, which has mainly been driven by the sell-off in tech stocks that's occurred over the last few months.
That dip has led to criticism of Wood's approach. Indeed, the portfolio is close to an all-in bet on tech growth stocks, so this portfolio will likely suffer deep losses if she is wrong. However, with the fund's history of market-beating performance and major growth potential for most of ARKK's holdings, the decline could mean a discounted buy price rather than the beginning of a years-long decline.
