There are five financial clues that suggest a stock is a disruptor. Think of these as financial guideposts. The most profitable disruptor stocks usually meet at least three or four of these criteria. The very best often exhibit all five.

Guidepost #1: Great Disruptors Grow, and Grow, and Grow

Every disruptor must pass the “growth test.” It must grow revenue year after year after year. Consistency is key. Companies that grow quickly then stagnate can make for good trades. They can earn you a quick buck if you sell at the right time.

I like to see revenue grow at least 20%/year. Disruptors that grow at this pace often reward shareholders with big profits.

Amazon is a classic example. For over 20 years, the online giant found new ways to grow, and grow, and grow. In fact, for 16 years in a row, Amazon has grown revenue by at least 20%/year.

That’s an astounding accomplishment. Over time, Amazon’s consistent yearly growth snowballed. In the last 16 years, its sales have exploded more than 5,000%! This led to early investors collecting profits of more than 115,000%.

Guidepost #2: Great Disruptors Make Heaps of Cash

So you’ve found a disruptor that grows consistently. The next question you must ask: Can it turn growth into profits? You’d be surprised at how many growing companies have no hope of ever turning a profit.

Generating a billion dollars in sales is great. But if you must spend 1.1 billion dollars to get there, there’s a good chance your business isn’t viable. Some unprofitable companies can survive for years on pep talks from a charismatic CEO. But eventually math always wins out. The best measure of profitability is net profit margin.

In short, net profit margin tells you the profits a company keeps for every dollar of sales. A 20% net profit margin means it turns every dollar of sales into $0.20 of profit. Companies with strong and growing profit margins hold a key advantage: They can reinvest that cash back into the business to keep growing.

Take Google (GOOG) for example. It dominates internet search, which is a high-margin business. For every dollar its core search business generates, it keeps close to 25% as profit. This keeps a constant stream of new cash flowing into its coffers. It has used much of this cash to develop and acquire disruptive projects.

For example, Google has plowed billions of dollars into its self-diving car subsidiary Waymo. Waymo is far and away the world leader in self-driving car technology. Waymo cars have driven more driverless miles than all other competitors combined.

Google has plowed well over $5 billion into Waymo. Few companies on earth have the ability to do this without borrowing gobs of money. I expect Google’s investment in Waymo to eventually pay off big time as self-driving cars go mainstream.

Google also owns Youtube.com—the second most-viewed website on earth. The #1 mostviewed website on earth, by the way, is google.com.

Google has also made investments in disruptive sectors like artificial intelligence and quantum computing. None of this would have been possible were it not for the profit engine at Google’s core. Its strong margins give Google the opportunity to make disruptive investments that could pay off tenfold down the road.

Now the truth is, a stock isn’t necessarily a bad investment because it lacks profits. Some companies, like Amazon, can go years or even decades without turning a profit. Lack of profits didn’t stop Amazon’s stock from shooting to the moon.

You might wonder why. In short, Amazon achieved such incredible growth that investors were okay with it not making a profit for a long time. For disruptors like this, the key is that the company has a path to profitability. The thing most analysts overlook about Amazon is it could have turned a profit long ago if it chose to.

Instead, it opted to keep selling things for dirt-cheap prices to grow its customer base. This resulted in zero profits but a soaring stock price.

Guidepost #3: Plenty of Skin in the Game

This one isn’t about financial performance. But it’s just as important. “Skin in the game” refers to how invested a company’s management is in its success. When high-ranking executives like the CEO have “skin in the game,” it means their interests are aligned with shareholders’.

Humans are wired to act in their own best interests. A CEO with a big part of his net worth on the line is likely to make better long-term decisions than one who is simply collecting a paycheck.

Facebook is a good example. When it was two years old and generating just $48 million in sales, Yahoo offered to buy it for a billion dollars. A management team with little skin in the game would likely have taken the money and run.

But founder Mark Zuckerberg had much bigger plans. Facebook is now one of the world’s largest companies, worth over $780 billion.

Guidepost #4: Great Disruptors Break the Rules

When evaluating disruptors, I do not read too much into valuation. Valuation measures how cheap or expensive a stock is. For traditional businesses, the price you pay for a stock is very important. But when it comes to disruptors, valuation metrics can often lead you to incorrect conclusions.

For example, for most of the past decade Amazon has traded at well over 100X earnings. By any traditional definition, this is absurdly expensive. The S&P 500 trades for around 20X earnings.

I know many professional investors who’ve avoided Amazon’s stock because it’s “overvalued.” They’ve missed out on Amazon’s 2,500% surge over the past 10 years. Please understand, I’m not saying we completely ignore valuations. My team and I look at them closely. When we evaluate an expensive stock, we ask: Why is it richly valued? Is the premium deserved?

If you’re evaluating a stock that has demonstrated it can grow sales 20% year after year, as

Amazon has, an expensive valuation shouldn’t scare you. But when a run-of-the-mill, slow-growing business is overpriced, you should usually run the other way.

The simple fact is, when it comes to fast-growing disruptors, growth and profitability are far better indicators of where a stock is headed than valuation. You’ll find that most disruptive companies trade for high valuations. Markets reward companies that grow fast.

Avoiding all stocks with high valuations is a mistake. It will lead you to missing out on the biggest gains. The inverse is also true. Stocks that trade for low valuations are usually cheap for a reason. For example, America’s largest car maker, General Motors (GM), trades for just 7X earnings.

Some folks see that as a bargain. To me it’s a red flag. GM’s sales haven’t grown in two decades. And the stock has been dead money for the past nine years.

Guidepost #5: Hunt for companies disrupting huge industries

The ideal disruptor is small compared to the industry it’s disrupting. Take The Trade Desk, a small company that disrupted online advertising and handed early investors big profits. In 2018, TTD’s sales totaled $477 million. Yet it was taking on the $725-billion global advertising industry.

As I explained at the time, Trade Desk’s sales could soar 1,500% and it would still own less than 1% of its target market. This gave its stock that the potential to double quickly—which is exactly what it did in the eight months after I wrote about it.

The key is, from there, it still had plenty of room to triple or quadruple again. At the time, competitor Facebook was more than 50X the size of The Trade Desk. And competitor Google was almost 100X its size! Which means Trade Desk could keep growing, and growing, and growing for years.

Another example: In late 2018, I alerted my readers to a company called Alteryx (AYX). As publicly traded companies go, Alteryx was small. It was worth just $3.7 billion—too small for inclusion in the S&P 500. But it was clear to me that it was quickly becoming a dominant player in the big and rapidly growing data analytics market. Leading research firm IDC estimated this market would be worth $81 billion in just three years.

AYX surged 62% in less than four months after I recommend it. Even after that strong rally, it had plenty of room to double or triple again. Small or medium companies going after giant markets is an ideal setup. We hunt for this combination because it can lead to almost unlimited upside in the stock price of a disruptor.

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