Investing
General

Disruption Score, Explained

The Disruption Score is a three-part assessment that has proven essential to my success with investing in disruptive high-growth companies. It is an assessment that takes advantage of my years of experience in engineering and entrepreneurship to evaluate the disruptive potential of a given stock - but it is simple enough that others could perform their own similar analysis. As some of you may have noticed, there are many similarities between investing in startups and investing in high growth publicly traded companies. That being said, investing in disruption often requires one to think like a venture capitalist just as much as an investment bank analyst. The disruption score provides a framework to thinking like a venture capitalist.
Read Full Idea

The Disruption Score is a three-part assessment that has proven essential to my success with investing in disruptive high-growth companies. It is an assessment that takes advantage of my years of experience in engineering and entrepreneurship to evaluate the disruptive potential of a given stock - but it is simple enough that others could perform their own similar analysis. As some of you may have noticed, there are many similarities between investing in startups and investing in high growth publicly traded companies. That being said, investing in disruption often requires one to think like a venture capitalist just as much as a traditional investment bank analyst. Just like startups, many high growth publicly traded companies have novel technologies, massive addressable markets, and carry very high risk for a variety of reasons. Keeping that in mind, I found it very valuable to analyze high-growth disruptive stocks using the disruption score analysis and then complement that with more traditional investment analysis methods.

Important Reminder

Before explaining Disruption Score, it is important to remember one of my Tenets of Investing in Disruption. There is a big difference between a company with strong long-term disruptive potential and a good investment in the near term. That being said, company valuations are not considered anywhere in the Disruption Score and for this reason it is important to use other metrics and research to complement the disruption score analysis.

Why have Disruption Score?

The disruption score is a great tool for a number of reasons. Firstly, it condenses a complex analysis into a single number which enables readers to

  • Provide a framework to analyze the long-term potential of a company like a venture capitalist.
  • Quickly convey to readers the long-term potential of a stock before they commit to reading the whole analysis - saving readers time.
  • Effectively compare the long term potential of various stocks, across industries. This also enables readers to sort stocks [when displayed in a table] based on disruptive potential and cross-reference other investment metrics, enabling readers to ask their own questions and make your own insights.
  • quickly get an idea about a company before committing to reading the whole analysis, saving readers time.

Additionally, it segments an in-depth analysis into three easy to understand assessments that, hopefully, make it more digestible and make readers feel more confident in their investment decisions.

What is Disruption Score?

The disruption score is comprised of three separate assessments that evaluate a stocks technology, market and risk. Each assessment is graded from 1-10, with 10 being the best. To determine the overall disruption score, simply take the average of the three scores. In hopes of making the concept as clear as possible, I had this illustration made as a visual metaphor to convey how technology, market and risk come together to describe a disruptive opportunity.

Disruption Score Concept Art

Just like the disruption score, the illustration above has three main components: the portal, the bridge and the castle (aka treasure). The portal represents the technology assessment, the bridge represents the risk assessment, and the castle represents the market assessment.

In this example, the illustration depicts a stock with a high technology score, a high market score and a low risk score. (Remember, low risk score is bad - means very risky.)

Technology

How it impacts disruption

Technology opens the door to disruption and provides barriers of entry to others, making it harder for others to gain access to the addressable market. Without technology, there is oftentimes no opportunity for disruption and, even if there was, the barriers to entry would be low and it would be easy for new entrants to come in and gain access to that market.

How it fits into the metaphor

Technology functions much like a portal to the disruptive opportunity, as depicted in the illustration above. Like a portal, technology is the only the beginning of disruption, but without it, the addressable market would be locked away forever. Similarly, the uniqueness and barriers to entry of a given technology determine if your the only one with access to the addressable market - or in other words -if your the only one with a portal to the castle.

Market

How it impacts disruption

The market assessment quantifies the value that could be captured by a given technology and, overall, helps you quantify the magnitude of potential disruption.

How it fits into the metaphor

The addressable market can be thought of much like a treasure, or the castle depicted in the illustration above.  The only reason to create the portal and risk crossing the bridge, is to attempt to capture as much of the castle as possible. Similarly, the goal of high growth disruptive companies is to capture as much market share of a disrupted market, or an entirely new market, as possible.

Risk

How it impacts disruption

The risk assessment evaluates the likelihood that a given stock will capture value from the addressable market and identifies the key assumptions involved in capturing market share. Without a realistic path to capturing market share, a great technology and a massive addressable market are worth nothing. On other hand, if a stock has a very clear path to capturing market share, than an OK technology and a moderate addressable market can be very worthwhile.

How it fits into the metaphor

Much like the bridge is the only thing connecting the portal to the castle, the risk assessment is the only thing connecting the technology to the addressable market. It takes into account any steps the company has made to come closer to the addressable market, as much as it considers all the obstacles the company must overcome.

How do you determine Disruption Score?

The disruption score is the average of three smaller assessments. Below are the general considerations that go into each assessment.

Technology Considerations

Considerations regarding if the technology has been proven.

  • What proprietary disruptive technologies does the given company have?
  • How developed is the technology?
  • Has the technology been demonstrated to function? Has the technology been used in a pilot test or beta site? Is it supported by industry experts?

Considerations regarding uniqueness and barriers to entry

  • How many years has the technology been under development?
  • Is the technology protected with patents?
  • Are there other companies with similar technologies?
  • Using your engineering expertise, how significant are the barriers to entry for competitors to recreate the technology?

Market Considerations

Considerations regarding the value of the market opportunity.

  • What is the value of the initial target market?
  • What markets would be disrupted by the underlying technology? what markets would be created?
  • What is the value of the total addressable market?
  • How easily could the company expand from the initial target market to the total addressable market?

Risk Considerations

Considerations regarding external factors

  • Is the underlying industry demonstrating growth?
  • What are the driving forces behind the growth? Are they sustainable?
  • Are there any trends that support the growth of this industry?
  • Are there regulatory hurdles for the company to overcome?
  • What are the greatest risks to the continued growth of this industry? How is this stock overcoming them?

Considerations regarding internal factors/execution

  • Is the company demonstrating sustained significant revenue growth?
  • Does the company have a large/growing pipeline of orders?
  • What is driving the revenue growth? Is it sustainable? [In other words, why is demand so high? E.g. Best in class customer reviews.]
  • What is enabling the revenue growth? Is it sustainable? [In other words, how is this company able to increase supply so quickly? E.g. Automated manufacturing facilities]
  • Does the company have a lot of capital ready to deploy on growth opportunities?
  • Is the company spending the capital wisely?

Considerations regarding strategic partners and investors

  • Has the company made any strategic partnerships?
  • Does the company have any strategic investors?
  • What percentage of the stock is held by insiders, hedge funds or institutional investors? [If insiders and big hedge funds own a lot of a company, that is a good sign. They typically have access to more information and have access to more resources to develop better analysis.]

Concluding Considerations

  • What conclusions can I draw from this particular combination of technology, market and risk?

Takeaways

  • Disruption Score on its own does not indicate if a stock is a good investment.
  • The technology, market, and risk assessments provide insight on their own, but provide more powerful insights when combined into summarizing conclusions. These conclusions can be found in the conclusions section of a given stock pick.
  • The Disruption Score is even more powerful when analyzed in conjunction with more traditional investment metrics.

Get full access to all of the ideas posted on this platform and much more.