Lessons From Mistakes - Cramer's Mad Money (7/6/16)

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Includes: AGN, EOG, LLY, MRO, PFE, TSN
by: SA Editor Mohit Manghnani

Summary

Know the company, not the stock.

Don't go against your research.

Commodity stocks cannot exceed commodity growth.

Stocks discussed on the in-depth session of Jim Cramer's Mad Money Program, Thursday, July 6.

"What makes a strong investment versus a weak one? When is a loss a good loss?" These are the questions that go through individual investors' minds all the time. Cramer dedicated his show on Wednesday to answering such questions and educating investors about his wins and losses so they can fine tune their judgment on individual stocks.

Cramer was also of the opinion that money managers who think that the stocks game is not for individuals are wrong. He has seen many home-gamers crush the market because they did their homework. That does not means he's against index funds. In fact, he believes that investing should begin by putting the first batch of money in a fund that mirrors a diversified index.

Cramer takes calls on stocks for his charitable trust from time to time, the proceeds of which go to charity. In this show, he talks about the things that go through his mind before taking a call on the stock. All these ideas will help investors judge better. His trust fund is divided into value, income and growth so each type of investor can pick his approach.

Differentiate companies from stocks

Cramer's first lesson in investing is knowing the difference between the company and its stock. This is important in the pharmaceutical industry where promise of a blockbuster drug may not always lead to blockbuster profits. The reverse is also true.

He gave an example of the '80s, where the stock market did not pay enough attention to studies that linked heart attacks to cholesterol. Ultimately, that class of drugs called statins became one of the best selling in history.

However, on the flip side, there are drugs that never get approval from the FDA. Cramer advised looking at the drug pipeline of a company to know the robust ones from those betting on single drug success. Avoid companies that have few or one drug in the pipeline that one day may or may not be approved for use by the FDA. They may be risky and never get approval, only to limp forever.

"When you have a drug company up against a difficult disease that many others have failed to cure, be more skeptical. There is a reason that others failed. It is an incredibly difficult problem to solve. The company you like might fail, too," said Cramer.

He also gave the example of Eli Lilly (NYSE:LLY) which his trust invested in on its Alzheimer's drug which could be worth billions. As time went by, the obstacles kept on mounting for the company. Cramer could not figure out when the company might see success, hence he sold out and moved on.

Whenever an investor is speculating, there should always be a fallback position. When they want to sell, do it at higher levels and buy when expectations are low.

Know the right from wrong

It is important to differentiate between the right and wrong. It's much easier to do it in hindsight, but to do it in the heat of the moment is complex as emotions are high. The benefit of being an individual investor with a well-researched idea is you can afford to be patient and wait for the right time to buy or sell.

Unlike fund managers, investors do not have clients at their throats for results. Cramer gave an example of a trade his trust made in 2015. They bought Tyson Foods (NYSE:TSN) after the company acquired Hillshire Brands in 2014. The stock was bought in the $40 range on the idea that they should get in early knowing the merger could be transformative for Tyson.

However, the merger came together slower than expected which led to estimates being cut and thus a fall in price for Tyson. They had researched well on the company, but lost patience and sold the stock. They did not wait long enough for their idea to yield results. They were not wrong, but they could not wait long enough to be right.

Sometimes you might be right but that would mean patiently waiting for the time instead of acting early and calling the right as wrong. Don't act on emotion and go against your homework.

Investing in commodity stocks

When it comes to investing in commodity stocks, it doesn't matter which stock is picked; if the underlying commodity is hit, they are all going lower. Cramer tried to avoid this principle by using a high-growth deep-value strategy. He bought the highest quality stocks - EOG Resources (NYSE:EOG) and Marathon Oil (NYSE:MRO) and got it wrong both times.

Even though EOG had the best properties and there was hope for Marathon being bought out, no one cared. All oil stocks traded together and the companies were not fast enough to cut costs to beat the price of crude. "Don't think you can outrun a commodity grim reaper, even with a derivative situation like a master limited partnership," said Cramer.

Cramer also lost money when the Pfizer (NYSE:PFE) and Allergan (NYSE:AGN) takeover was aborted. Both companies had crafted the deal to meet the terms laid out for approval with the U.S. government on tax inversion laws. As the deal was nearing a close, the government changed the rules. "What did I do wrong? I trusted the government to keep its word," said Cramer.

In an era when deals are being quashed, he shouldn't have had a reason to believe that this deal will go through. He realized he was being greedy and the Pfizer-Allergan merger was dangerous. "In this business, greed is just plain bad. Don't let anyone on or off screen tell you otherwise," he added.

Growth stocks

Growth stories are hard to come by and on Wall Street which is eager for growth, stocks go out of favor quickly. Facebook (NASDAQ:FB) was once considered a disappointing company that failed to live up to its potential for about a year after it went public. It appeared as if Facebook had missed the desktop to mobile migration bus and the stock declined as a result.

When Facebook (FB) was trading in the $20s, Cramer found from the transcripts of the conference calls that not only had the company reported a good quarter, but they adapted to mobile and advertisers were rushing to Facebook. Cramer bought Facebook's stock for his trust and let the growth ride. He also noticed that the numbers were improving every quarter but the PE remained same. This is a good situation as one is paying the same amount for bigger growth.

The same was the case with Cisco (NASDAQ:CSCO) which was written off. CEO Chuck Robins recognized that it was time for the company to transition into a software company with a niche in cyber security. After the transition, the stock has gained. Cramer believes that it is still in early stages and has more room to run.

"When everyone writes off a tech company with one of the best balance sheets, I say wait a second, aren't you just running from something that might be in a terrific transition?" concluded Cramer.

Viewer calls taken by Cramer

Should a 15 year time horizon IRA be all in a diversified index fund? "Yes, that's a great way to handle it."

How to look for the next possible acquisition? Look at the sectors that don't have enough bandwidth to be bigger which means that one has to gobble the other to grow.

How to adjust the costs basis while trading around a core position? Cramer does not like taking off the table unless the stock is up 25%, or buy more if the stock is down 20% to avoid fees.

What metrics should be used to find out if the dividend is safe? Cash flow analysis and dividend payout ratio are the 2 most important metrics.

What number of stocks should a diversified portfolio have? Most people have a hard time following more than 10 stocks.

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