Today I’m going to do a special blog where I skim the book one last time, and pick out points I like and put them here for me to remember later. That being said, let’s go!
I’m going to start off with the point that stocks are pieces of paper. There’s no HOME team! Markets and businesses change. Sometimes good, sometimes bad. Don’t HOLD a stock and hope that it comes back. Sometimes HOLDing can be much more dangerous that selling at a loss. Don’t get too emotional. It’s a stock!
Buying and selling stocks is profession without standards. “Professionals” may be no better than you or me when it comes to this stuff. Here is some conventional wisdom that Cramer said is part of the reason he failed when he started. 1. Buy and hold because that’s how you make the most money. Cramer changes this to buy and homework. Do an hour of homework each week per stock to see if it’s worth holding. 2. Trading is always wrong, owning is always right. If you really want to make money, you are going to have to lock in those profits sometimes, especially after nice runs. 3. Speculation is the height of evil. However, speculation is what makes investing fun, it makes it exciting and interesting, and overall some of the bigger gains you will receive is by diversifying and investing in speculative stocks.
When evaluating stock’s worth, you can’t think about how much you bought it for eons ago, the only thing that matters is what is the stock going to do next. The future! Sometimes the past can make you blind, and you get all emotional. Losing X dollars can really blind you on what the potential future can be.
Always you limit orders. I know what it is, since I did it so much lately. It’s easy, it’s a price you put in when buying or selling stocks that you want or better. So a limit buy is $X or less, and a limit sell is $X or higher. Never use market orders, cause that way, the broker has the right, no, the obligation to rip you off.
The value of the stock is not based off the actual dollar amount. A $40 stock may be more expensive than a $400 stock. First we have to find the price-to-earning (PE) ratio. Take the stock price and divide it by the PE ration and you get x time earnings, or (M)ultiple. M * PE ratio = Price of stock. Easy right? Stocks tend to be more expensive mainly because of a company’s past growth. Those that grow faster will have a more expensive M. But the example given by Cramer is the Super Bowl. If you made a friendly wager in the game, you know that people usually bet on the better team. But why do people bet on the underdog sometime? It’s cheaper and the rewards are much higher. Get my drift? Just make sure that the stock you choose is growing at a rate that is consistent with the price, because if it’s not maybe one of those could be a steal! Oh, and other ways to value a stock is by how much dividend is paid. Don’t get bound by the math however, there are many more brighter minds out there that can do this as well, but we’re here to exploit the anomalies in the stocks.
Jim Cramer tells his experience about AT&T. AT&T was plumetting due partly to bad management. However, as it was falling, Cramer started to love this stock. Because not only is the stock a piece of paper, but it’s also a living company. Just because it’s price and growth are bad, check out what the company is doing, how much infrastructure they have, will they survive? If yes, buy buy buy that damaged stock! It’ll be nice for you once it comes back to life on paper!
Divesification is th only free lunch. 5 is the minimum to be divesified according to Cramer, and 10 may be the max, otherwise you are a mutual fund (and will have a lot of homework!).
So what’s homework? Quick summary, every report from the SEC (quarterly and annually), important articles, conference calls, and analysts’ reports. Listen to conference calls before you buy a stock. OK, I’m guilty, I haven’t done this yet! But I will! What are you looking for? Growing sales, high gross margins, basically see how the company is doing and get a feel for where it’s at.
Businesses that do well in a booming economy are “cyclical”. Ex. farming, road building, military, aircraft. Those that do well regardless are called “secular”. Ex. medicine, food, hygiene, etc. Another important thing to look for is their metric or series of metric. Like revenue per room, revenue per seat, gross margin per product, etc. So you can compare apples-to-apples.
Remember, buy companies that grow faster than competitors, and grow faster than the S&P but still have a (M)ultiple that is as low as possible. Also, Cramer likes companies without a lot of debt. Too much debt can be bad for the companies, because they may not be able to pay their bills, and may be headed in a downward spiral. It takes one really bad investment to screw up your portfolio!
Charts! Never enough to buy a stock from! Anyway, make sure you know what your M is, how fast your earning are growing, and also give a guess how much the stock may decline (such as 25% M), and check out your risk reward for both. The example Cramer gave was Rite Aid vs Walgreens. Walgreen grows earnings 15%, $30 trade, and 25 M. Rite Aid grows at 12.5%, $5 trade, and 40 M (times earnings). If Walgreens earns $1.30 more, reached upper limit of 40 M, then Walgreens will go to $52 a trade (or +$22). Rite Aid probably has no gain since the M is the upper limit. Now check out the down side or 75% M. If Walgreen earns 1.30, you can say $30 [Price/share] / ($1.30) [Earnings/share] ~ 23 (M) and $23 * 75% = 17 M or $22/share. Rite Aid with $.26 earnings would yield 14 M or $3.64. The differences there would be WAG $8 and RAD $1.5. So WAG is 22 up and 8 down where RAD is 0 up and 1.5 down. WAG is a better deal! But there are many more factors that go into this, but here is a good arithmetic start! Make sure to find these calculations on the S&P as well to have a benchmark to test this on.
Ugh, I though I could cover this all in one post, but I may need to come back and hit the other half of the book. IT’s long, but lots of useful info. Please take a read of this book, because it helped me a lot, and I hope it can help you. I’m looking forward to his Getting Back to Even book coming out October 13th. I’ll add more tomorrow (and then I have to return the book).