The 14 Truths You Must Know When You Invest

08/18/03 - 02:54 PM EDT

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Furthermore, individual stocks have gotten much more volatile, meaning you have to own more of them to achieve diversification. If pharmaceutical stocks such as Merck(MRK - Cramer's Take - Stockpickr) and Pfizer(PFE - Cramer's Take - Stockpickr) have a high correlation, you only have to own two or three to get diversification in the sector. If they have a low correlation, you have to own them all.

Buy buying individual stocks, you lower your odds of achieving your financial goals.

Truth 9: Reversion to the Mean

In order to justify high P/Es, you have to have abnormally high growth. Robert Haugen wrote about this. In order to justify high-growth stocks, they have to post outsize growth for seven years; it only happens for four years on average.

Reversion to the mean with stocks averages 40% a year, according to Fama-French studies. The bigger the profit growth, the more incentive there is to enter.

You would think the market would incorporate this information, but it doesn't -- we had the Nasdaq 1000 trading with a P/E of 250 in 2000. If you have a stock that trades at an price-to-earnings multiple of 80, if you're growing at about 80% for 10 years, then you're OK. But no large-cap stock that ever traded above a P/E of 50 justified its valuation. Only 3% to 4% of all stocks justify that level, and they are mostly small-caps.

Truth 10: Forecasts Have No Value Except for Entertainment.

Studies have found that economic forecasts have no real predictive value. Forecasts from the Federal Reserve, the [Congressional Budget Office] and the [Council of Economic Advisors] were worse than random forecasts, yet they have a real impact on the markets.

The basis of any forecast about the market begins with an economic forecast. If you can't get the economic forecast right, you can't get market forecast right.