Note: Tuesday's program was a rebroadcast of a show that aired on December 28, 2006.
Rule #1: Resisting the Business Cycle, United Health Group (UNH)
Cramer discussed more rules from his books: Jim Cramer's Real Money: Sane Investing in an Insane World, and Jim Cramer's Mad Money: Watch TV, Get Rich. His first rule deals with the business cycle which is largely controlled by the Federal Reserve's raising and cutting interest rates. When rates are reduced, the economy gets stronger, and investors should buy cyclicals such as "the dirty, smokestack stocks that make things like machinery, cars and minerals." When the Fed raises rates, the economy gets weaker, and it is time to get out of cyclical stocks and into companies that produce consumer staples, such as food and drugs. "You can't own cyclical stocks when the economy stinks, and you should stay away from the consumer staples when the economy's stronger," Cramer said, adding that this applies even if a company has strong fundamentals. He recalls his error of holding on to UNH when the economy picked up, and said that the selloff during the boom was a much bigger factor in the stock's decline than UNH's involvement in an options-backdating scandal.
The reason for the second rule is that analysts covering a stock are dealing with an entire sector for which they must find some stocks that are buys, sells and holds. "The Street will almost always treat a sector that's en fuego as being a lot less en fuego than it actually is," he said. Knowing this, investors can more easily spot which sectors are hot but underappreciated.He noted that this happened with oil stocks during certain times in the past few years when the sector was hot. Even the companies that were neglected or had a "sell" rating went up anyway. It can work the other way too, and Cramer thinks that analysts should have stayed bearish on eBay, Amazon and Lucent for a longer period of time.
Because analysts inhabit an upper-class bubble, Cramer says they often miss out on companies that make low-end or mid-grade products. While they can more easily relate to stocks such as RUTH and MRT, most analysts missed out on 50% of Darden's big move between January 2005 and March 2006 because they turned their noses up at Red Lobster and the Olive Garden.
Rule #4 : "Whenever a stock is being heavily shorted and heavily hyped at the same time, it's time to sell that stock," NutriSystem (NTRI)
Hype and a large short interest do not mix, but create a battleground where an investors should fear to tread, and Cramer commented, "You don't do something as risky as shorting a stock unless you're a well-educated investor who has done his or her homework on the thing." One can do research on a stock page on Yahoo or Google finance to see the percentage of shares that are shorted, and a large percentage of shorts indicates that there is a problem the bulls don't know about or do not want to face, as was the case with NTRI, which had problems with its distribution model. "So when all the analysts are having their lovefest with the stock, and you have an army of shorts sitting on the sidelines, you should see a red flag," Cramer said.
"Past performance is not indicative of future success."
Cramer warns viewers not to rely on past successes as a model for future investments, since "stocks have no memory and you could lose big." Investors should aim to make money, but not to feel "invincible" if they do and should avoid following the same patterns. Cramer recommended playing by the rules outlined in his books for successful investing.
Seeking Alpha publishes a summary of Jim Cramer's stock picks every day including: Mad Money Recap, Lightening Round, Stop Trading and his Market Minute.
Get Cramer's Picks by email -- it's free and takes only a few seconds to sign up.
Seeking Alpha is not affiliated with Jim Cramer, CNBC or TheStreet.com