Jim Cramer’s Real Money Sane Investing in an Insane World



Jim Cramer’s Real Money: Sane Investing in an Insane World



I. Introduction

A. Most investing books, like most of the mutual fund managers would do worse for

you in the stock than if you picked a portfolio of the Standard and Poor benchmark

of 500 stocks.

B. Cramer builds in speculation, similar to the way that good-tasting beef is built into

the Atkins diet.

C. Remember the biggest return generators of our life, the Home Depots, the Best Buys

were incredibly risky, if not considered outright dangerous, just when you had to

buy them aggressively. These were the stocks that turned thousands into millions

but would have been avoided by conventional investors because they were too

dicey.

D. Cramer wants you to like the equity (stock) regimen. Why equities? Because every

academic study shows than in any twenty-year period in history, no asset-

outperforms high-quality equities that can pay good dividends.

E. Cramer says if he cam make you money legally, using speculation, who cares if we

do it with nonacademic methods, because making as much money as possible in a

short period of time is the goal.

II. Chapter 1—Staying in the game

A. Cramer says his first job reminds him that the opportunities (in stocks) are too great

not to be in them.

B. “Say in the game” is the only mantra that is worth repeating. It keeps you from

picking stocks than can wipe you out. It keeps you from speculating on situations

that is worthless.

C. Cramer has been able to make big money when big money could be made because

he was not discouraged or fed up or desperate when times got tough…..because

he knew that when the game eventually turned he would be there to pounce on

what was to be gained.

D. Staying in stocks (the game) makes sense rationally and empirically because, over

the long term, we know stocks outperform all asset classes.

E. The reason more people do not get rich with stocks, is….They get bored, tired,

frustrated, defeated or reckless. They get discouraged. They get beaten…not by

investing, but investing “successfully.”

F. Managing your own money is like playing hockey, where everybody has an

opportunity to defend and to score and everybody is expected to take the

opportunity.

G. Do not buy or sell on emotion.

III. Chapter 2--Getting Started the Right Way

A. Stocks can be fathomed, but you need the basics.

B. Cramer has always believed that stocks can be mastered if someone would just

show him the landscape.

C. Three foolish rules (not to believe in).

1. Buy and Hold Stocks because that is how you make the most money.

2. Trading is always wrong, owning is always right.

3. Speculation is the height of evil.

D. Buy and Homework

E. Am I Diversified?

F. Reminiscences of a stock operator by Jesse Livermore (pseudonym Ed Lefevre).

G. Picking Winners by Andy Beyer

H. Three Smart Rules:

1. If you learn from mistakes, you will not repeat them.

2. Only go the tracks (stock markets or go to stocks) were there are not a lot of

good players so you can clean up (only invest in stocks where the research and

information is not perfect and many minds are not trying to figure it out).

3. Only bet on situations where you have total conviction.

I. Two reasons to own stocks:

1. There is an enterprise value to the whole company than can be bought or sold and

can grow over time from the retained earnings of the company (dividends). If you

own a stock that pays a dividend, you could be getting both the income stream

and value of an appreciating stock.

2. Stocks are not perfectly priced.

IV. Chapter 3—How stocks are meant to be Traded.

A. The only thing Cramer cares about with a stock is what is going to happen next.

B. Owning a stock is a bet on The future, not The past.

C. Jim Cramer’s wife known as the “Trading Goddess” used to ask Cramer what he

“thought” and how he “would rank” a stock on a scale of 1 to 5, 1 being a stock he

wanted to buy more of right now and a five being one I need to sell pronto.

D. Lesson # 1 in trading stocks—when it comes to buying or selling a stock, do not tell Cramer “why you bought it, only where it is going.” That is all that matters.

E. When professional traders buy stocks they call it “taking the stock” a sell is called

“sell at market.”

F. Lesson # 2 in trading stocks. Always use limit orders when you buy or sell any

stock especially when you are buying in unseasoned situations (IPO’s, new stocks,

or just issued stocks like The on the day it went public.

G. What matters is (for a stock anyway) is the price-to-earnings ratio of each stock. To

figure the price-to-earnings ratio you need the last price of a stock and divide it by

the amount per share the company earned in the pervious year. Example: $27.00

divided by $2.18 and you get 12 (rounded to the nearest whole number). M x E =

P or 12 x 2.18 = $27.00.

H. We take the earnings and we figure out what we are willing to pay for the earnings-

the multiple-then we times them and arrive at the price.

I. The formula can also help us figure out future prices. If we know what the earnings

estimates are going to be (E) and we can figure out what might be willing to pay for

those earnings (M) we can arrive at a future price or we can figure how above or

below a stock might be from what it might trade in the future. The multiple allows

us to make apples-to apples comparisons with the stocks or other companies in the

cohort.

J. If we have the price, and we have the future earnings estimates, we can measure

whether we are paying too much or too little for the stock now versus its peers.

Any change in the earnings estimates or any change in the economic landscape

(such as lower interest rates) can affect what M we will pay.

K. The subjectivity is in the comparisons to other equities of similar nature. Now we

something that allows us to compare two companies; we have something that

explains the relative worth of each company’s shares.

L. The real reason why one (stocks) trades more expensively than the other is that one

grows faster than the other.

M. How is growth measured on Wall Street? To chart future growth, you have to start

by looking at the pattern of earnings per share, or EPS. Wall Street pays a

premium for high growth and awards a discount for slow growth.

N. While not always an accurate predictor of future growth, past growth is terrific

starting point.

O. In business, a company is favored because it has more consistent growth over

time. The company is favored, and the cheaper company is the underdog.

P. We are looking for imperfection (in the market and also something called

imperfect information). Is there something about that pricing that could be

wrong, either higher or lower (earnings) than it should be.

Q. Look at companies with capitalization between 100 and 400 million dollars. These

stocks are considered to be speculative.

R. Also consider dividend yields as well. To calculate the yield say you earn 72 cents

you divide that by the share price $27.00 and you get 2.5.

S. Cramer agrees though that a company which grows its earnings twice as fast as

another company might eventually boost its dividend at a faster pace.

T. Most analysts only look at the P/E ratio and the growth rate. Analysts consider whether or not the companies are growing slower than or faster than all companies (in all stock markets) based on the P/E ratio. Look for companies that

are 2nd or 3rd in their industry group because they could a target of a takeover by

another company.

U. Sometimes analysts only consider the stock as a piece of paper, not as a company

with an ongoing business. Wall Street loathes stocks as come down in price

(earnings) because they (Wall Street analysts) think the companies ratios are more

important than earnings. Cramer loves stocks as they come down, because he

knows the enterprise underneath (the business) may not be deteriorating as fast as

the stock price.

V. Look for stocks where the merchandise underneath is not badly damaged but just a

damaged stock price.

W. What is the company’s gimmick (or story) so you can distinguish between

damaged companies and or damaged stocks. Websites like Factiva and First Call

can help us do that.

V. Chapter 4-Some Investing Basics

A. Consider two streams of income:

1. The necessity stream

2. Discretionary stream

B. Homework-you must read every report from quarterlies to the annuals, you have to

listen to all of the conference calls, and read all the analysts reports.

C. When listening to conference calls you are looking for how the company is doing.

What is the temperature of the company? If your company is young you are

looking for fast growth. Older companies look at dividends.

D. How can you tell if a company is doing better or about to grow earnings faster than

would be expected?

1. The rate of revenue growth.

2. Gross margin or how much profitability each sale can generate.

E. Some businesses have higher-margins because they have little competition

(monopolies). Examples Apple Computer, Intel and cable companies. Look out for

satellite T.V.

F. Some other businesses such as drug companies have patent protection that gives

them a hefty payout for 17 years (however after the 17 years the patent is worthless)

unless they develop new products.

G. Some companies have big profit margins only when the world’s economy is

booming. These are called “cyclical” concerns. Examples would be farming,

road building, military, aircraft building, have big profits during the “boom.”

H. Others have profit margins regardless of the world’s economy. These are called

“secular” growth stories because they are independent of the cyclicality of

economies. Examples of these types of companies are Cola and Medicine.

I. Each industry has what is know as a metric or a series of metrics that measure

how it is doing versus its peers.

1. For example the cable industry uses enterprise value per subscriber.

2. Hotels –average revenue per room.

3. Retail Stores and Restaurants—same-store sales.

4. Airlines—average revenue per seat.

5. Technology—gross margin per product sold.

6. Financials—net interest margin.

J. You want to buy cyclical stocks only when the “line” or multiple to earnings is so

out of whack with the growth prospects that you are compensated for the

vicissitudes of the consumer and the economy.

K. The main thing that homework should identify is whether your company is

growing faster than the average company. To determine that, you take the

company’s P/E multiple and compare to the average company (in the

industry your looking at) P/E ratio.

L. A bargain company is one that is growing sales and earnings faster than the

average S & P ( S & P refers to the Standard and Poor’s Stocks) company; BUT

sells for a lower multiple than the average (S& P company)company.

M. Value investors look at or for something good (in a company) like a takeover

or turnaround. These buyers look at abstractions such as book value, and or

replacement value of an enterprise, or what other companies have been

willing to pay for similar entities in the same industry.

N. When doing analysis on an individual stock compare the numbers versus the S & P 500.

VI. Chapter 5-Spotting Stock Move Before They happen

A. The essence of a stock move is simply supply and demand. Supply and demand

determine the minute-to-minute pricing of stocks.

B. In the real world, there are many forces that can affect the pricing and selling a

stock that does not have much volume. Finding out when a stock is about to have

a “Game Breaker” move requires only some knowledge about the way stocks work

as they grow.

C. The landscape to Cramer look likes the following:

1. There are undiscovered companies that are undervalued stocks. The typical

(unfortunately) uninformed speculators are buying stocks already exploited by

the process of discovery.

2. We begin to believe that the catalyst for a big move requires a recognition that

there is more growth to come than anyone knows.

3. There are four (4) groups or types of stock moves:

a. Undiscovered/Undervalued company

b. Discovered/Undervalued company

c. Undiscovered/Fully Valued company

d. Discovered/Fully Valued

D. The earlier you move (buy a stock), the more your actions resemble gambling.

However, the earlier you pounce, the greater gain you can have.

E. The reasons behind traditional moves of large cap stocks can be grouped into

two logical catalysts:

1. Rotational Catalysts: Decisions by portfolio managers to shift from group

to group depends upon the macro economic backdrop: weak-to-strong economy

dictated by the Federal Reserve. These involve switching between secular

growth to cyclical stocks.

2. Estimate Revision Catalysts: We must be able to detect when companies’

estimates are going to rise. We have to be able to spot product cycles or

demand cycles before they occur so we can profit from surging estimates.

F. The discipline involved in the undervalued and unknown stocks are completely

different than those involving large capitalization. The reason is most small caps

never will reach big cap size.

G. Cramer believes that sector analysis and specific stock analysis explains about

50% of a stock’s move. He also believes that no matter what how good a stock may be it cannot get away from it’s sector.

H. The vast majority of stocks is driven by the formula E x M = P. There are only

two (2) ways a stock can obtain a higher price in the market.

1. The earnings can go up.

2. Someone will pay a higher multiple for those earnings.

I. New product introduction, better sales, better margins—is the reason for higher

earnings estimates.

J. The first reason a multiple expands or contracts is the macro (economics)

concerns which is known as “top down” thinking which means, that if you have a

understanding of the nation’s economy you can predict the multiple’s direction.

You can measure the multiple simply by looking at where a stock has traded at

(stock price) and earned in the past. The way Cramer explains this is to say that

“the M anticipates the E, and if you shift your portfolio towards stocks that should have a greater E when the economy is about to expand, you are going

to find yourself riding a wave of multiple expansion. The P/E multiple of all

sectors responds to the giant macro picture.

K. Cramer uses a chart or as he calls it his “playbook” what or what should not be

bought in the various parts of the economic cycle they include:

1. -2 with the economy expanding back toward flat lining; 0 to 7%. In a

recession, the Federal Reserve can be counted on to cut interest rates on the

short end.

2. When you get to a recession, the stocks with the highest multiples are those

of companies with recession-proof earnings:

a. Drug companies

b. Food companies

c. Soap and Toothpaste companies

d. Beer and Soda companies

At a slowdown’s depth before the Federal Reserve takes any action, these

stocks are prized possessions (when cyclical companies are missing

estimates i.e. Proctor and Gamble). At the height of the recession you switch

from recession proof companies to beaten down cyclical (when companies are

at 25 to 30 times earnings). After that you switch to smokestack companies

that are cyclical in nature and finally discretionary stocks.

3. When the Federal Reserve lowers interest rates it is a big event for cyclicals. As

the downshift occurs (at the very bottom of the cycle) prices are crushed. When

When the cyclicals are downgraded by the analysts and their multiples are at

their highest is the time that you buy and you sell your noncyclicals when their

multiples are their highest.

4. Some stocks known as secular growth stocks can transcend almost all cycles

because they grow so fast. Examples are Yahoo!, eBay, and Amazon. They

have organic growth and are not interest rate sensitive.

5. Since sector rotation is so hard to detect, you can also consider investing in

Exchange Traded Funds.

6. As interest rates rise you will see all things financial (real estate, savings and

loan, banks, insurers, brokers, mortgage companies, and home builders) trade

lower. During this period, though technology and cyclicals will do very well.

7. When the economy goes to 5% you start selling retailers and autos because the

economy is being impacted. At this point add more tech and deeper cyclical

stocks.

8. When the Fed (Federal Reserve) hikes interest rates to 6% we have to anticipate

that the tide (future lower interest rates) is about to go out. Sell your cyclicals

and techs. Put the money in the bank. At this point, the business cycle shuts

down because, it is prohibitive expensive to build up inventory due to higher

interest rates. The inventory cycle is busted (this is what causes the Fed to

lower interest rates).

9. At this point, you switch to consumer staple stocks, the ones that do the best

without economic strength—Proctor and Gamble, Kimberly, Colgate. When

they hit their 52-week highs (when their M’s are most steep) you sell them

and buy homebuilders and insurers mortgage companies and retailers. When

the elephants move in (mutual fund companies), they move stocks with them.

K. The second and more important reason way to predict a big move is to try

and figure out possible changes in E portion of the formula E x M = P. The

more realistic approach to gaming the E is to try to anticipate “spending cycles,”

particularly capital expenditure cycles.

1. Interest rates are a major component of what we pay for future earnings, for

the “growth” of the enterprise we are investing in.

2. To determine the value of earnings you use the prevailing rate we use for a

bond.

a. In low inflation, we would tend to want to pay a lot for these earnings.

At times when inflation is high and bond prices are going down-with yields

going higher-we want to pay less. We are only willing to pay higher

earnings when inflation is lower not higher.

b. We must pay close attention to these notes when looking at cyclical stocks.

We must anticipate when the Fed will raise or lower interest rates. You

cannot wait until the Fed lowers the rates.

c. “The Federal Reserve slows down the economy when the economy is

making A’s (anticipating inflation) and lowers rates when the economy is

flunking (when the Fed has killed the inflation).

L. The third method of divining big moves is one called the undiscovered stocks

of unknown companies.

1. Cramer likes to focus on stocks that have a small capitalization that should not

be small because the companies underneath them have too much potential to

be stuck with such an appellation. These stocks have the least information, the most ignorance, and the greatest potential. These stocks use crowd psychology

and behavioral psychology.

2. To begin to spot the best “small caps” you have to do the numbers. Start by

doing a Google search on a certain new field and find companies that are

public (example: nanotechnology). If there is no major coverage of the group

you pounce on the group. If there is coverage on the group you do not look at

the group.

a. Check out trading volume of these stocks.

b. How do you spot tops of these stocks by measuring supply and demand.

Near the absolute top its difficult to spot but merchandise that was

considered hot begins to sag. Secondary offerings of stocks already public

begin to pop up because sellers can sell their stock. Supply overwhelms

demand.

3. Steps to pick up the next big gainers:

a. 40 % management

b. 30% fundamentals—cash-flow, growth earnings, growth/potential balance

sheet, liquidity. They have real revenues and rapid growth.

c. 15 % technical analysis—these stocks work only when the size of the stock

is too “small” for the concept and has to be super sized quickly by the crowd.

Cramer likes to work off a scan that yields stocks that:

c.1. have a minimum of 100,000 shares

c.2. 100 million in market capitalization

c.3 and a price between $ 1--$15.00.

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