Note: The Following Mad Money episode is a rebroadcast of a show that first aired on June 25, 2007.
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Rainy Days and Mondays
Cramer devoted Monday's show to giving his viewers more insights into how he trades. For those who are frustrated with "rainy days," Cramer suggests using down times to shop for fallen stocks, particularly those which are upgraded by analysts, since they usually go up after the selloff is over.
While the term "undervalued" is thrown around alot, Cramer provided a formula to determine the value of a stock. "If a stock has a price-to-earnings multiple -- remember E (the earnings) times M (the multiple) equals P (the price) -- that's lower than its growth rate, then that stock is cheap," Cramer said. However, he warned this is not a hard and fast rule, since stock may seem cheap because earnings estimates need to be cut, are not such good buys if their fundamentals are declining, or if they are going to miss their earnings targets. Similarly, a stock may seem expensive, but "if its earnings need to be revised higher, its multiple will come down, and it has more room to run," said Cramer. While the market is dynamic and does not lend itself to rigid rules, Cramer emphasized stocks with accelerating growth are more valuable than those with de-celerating growth, which should be sold. Even if one envisions a comeback for a sluggish stock, it should be sold and re-purchased, according to Cramer.
It is very difficult to determine when a stock has bottomed, and instead of predicting the lowest point, Cramer would buy with "wide scales" on the way down, gradually purchasing more; "when it's so low you can hardly believe how poorly the stock is trading, you double down," he said. However, it is still important to leave room to put more money in when the stock finally bites the dust. Good indications that a stock has bottomed are when most of the analysts have downgraded it or when it doesn't decline lower on bad news. Heavy insider buying after a decline is a "sure sign" a stock is a buy.
When Bad Things Happen to Good Stocks
Cramer took issue with the notion that when a stock gets hammered it somehow deserved it; "Plenty of great companies are unfairly sold off by investors who simply don't get it," he said. He emphasized homework is necessary to determine the difference between a broken stock and a broken company. Cramer recommended making a shopping list of favorite companies which are being forced down. He warned against assuming a so-called "blue chip" stock is invincible, because "there is no such thing as a blue chip." Finally, when Cramer would sell into strength when the stock has completed its run.
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