Rule No. 4: Buy Damaged Stocks, Not Damaged Companies

Editor's note: Jim Cramer's new book, Real Money: Sane Investing in an Insane World, is available in selected bookstores now. As a special bonus to RealMoney readers, we will be running Cramer's "Twenty-Five Rules of Investing." For more about the new book and to order it, click here. Today, we present Cramer's fourth rule of investing. To read about his first rule, click here; for his second, click here; for his third, click here.

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Let's say Wall Street is holding a sale of solid merchandise that it has to move. And let's say you take that merchandise home only to find it doesn't work, has a hole in it or is missing a key part. If we were on Main Street, of course, it wouldn't matter. There are guarantees and warranties galore on Main Street. You can take anything back.

You can't return merchandise on Wall Street and get your money back. Nope, no way.

Which is why I always say:

You have to buy damaged stocks, not damaged companies.

Sometimes these buys are easy to discern. In 1998, when Cendant(CD) was defrauded by the management of CUC International through a series of bogus financials, the stock went from $36 to $12 in pretty much a straight line. Was that a one-day sale that should be bought? No, that was a damaged company. It took years for Cendant to work its way back into the hearts of investors. Some say it has never recovered.