Bad Buys Won't Become Takeovers

Editor's note: As a special bonus to TheStreet.com readers, we will be running an updated version of Jim Cramer's "Twenty-Five Rules of Investing," from his latest book, Real Money: Sane Investing in an Insane World. Here's Rule 10.

Nothing's more exciting than a takeover. Nothing's as lucrative. You can put on a lifetime's worth of moves in a day from a takeover. So people go to great extents to try to get them, including buying a lot of bad companies in the hope of catching one takeover.

Funny thing about bad companies: They rarely get bids. In fact, the companies that get bids are great companies with cheap stocks, not crummy companies with expensive stocks. Yet that's what people buy, all the time.

Here's my rule:

Never speculate on companies with bad fundamentals.

The odds are that you will end up owning something that could go down much more than you thought, but that has very limited upside. You can make much more money buying a company that is doing well and can still get a bid, than you can buying a company that is doing poorly and is unlikely to get a bid.

Any time I deviate from this rule I get burned, particularly when I approach a stock as a nontakeover story and then the fundamentals go awry and I try to shoehorn it into a takeover story. Take Nortel(NT). After the accounting fiasco, I consoled myself that perhaps the company would be acquired because it was so cheap. That proved to be a sucker's game, because the company simply couldn't put out financials. Maybe one day Nortel will get a bid, like Lucent, but I have a feeling that it won't happen soon enough to make up for the time value of money.

Some people have stayed in painful stocks believing that lightning could strike. Meanwhile, if they had moved on, they could have bought high-quality companies that moved up over time and could have done much better.

When you're scouting for companies where the fundamentals are cheap and the takeovers are likely, remember that, unlike companies with bad fundamentals that you speculate on, if these go down you don't need to cut and run. If they don't get a bid, you still can win.

And you need multiple ways to win, at all times.

	1.	Pigs Get Slaughtered		2.	It's OK to Pay the Taxes
	3.	Don't Buy All at Once		4.	Buy Damaged Stocks
	5.	Diversify to Control Risk		6.	Do Your Homework
	7.	Don't Panic		8.	Buy Best-of-Breed
	9.	Defend Some Stocks		10.	Don't Bet on Bad Stocks
	11.	Own Fewer Names		12.	Cash Is for Winners
	13.	No Regrets		14.	Expect Corrections
	15.	Know Bonds		16.	Don't Subsidize Losers
	17.	No Room for Hope		18.	Be Flexible
	19.	Quit When Execs Do		20.	Patience Is a Virtue
	21.	Be a TV Critic		22.	When to Wait 30 Days
	23.	Beware the Hype		24.	Explain Your Picks
	25.	Find the Bull Market

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