Cramer's 'Mad Money' Recap: Demystifying Wall Street (Final)
This episode last aired on Aug. 30, 2011.
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NEW YORK ( TheStreet) -- "Investing isn't easy, but it doesn't have to be mystifying," Jim Cramer told the viewers of his "Mad Money" TV show Friday, as he dedicated the entire show to helping translate Wall Street gibberish into plain English for individual investors.
Cramer's first words in the Wall Street dictionary were "secular" and "cyclical", two important ideas that go hand in hand. He explained that cyclical companies need a strong economy in order to grow. Think steel, machinery and chemical stocks. Secular growers, on the other hand, keep growing regardless of the economy. Cramer said these are companies that make anything you eat, drink, smoke, brush your teeth with, or use as medication.Why are these distinctions important? Cramer said its because they help determine how much a company will earn in a given environment. He said the hedge fund playbook was written on buying and selling these powerful trends. This is why the philosophy of buy and hold is silly, said Cramer. Why would anyone want to hold onto a stock that's out of favor? During times of recession, said Cramer, investors need to sell the cyclicals and buy into the secular names. And when the economy is recovering, it's time to sell the seculars and jump back into the high-growth cyclicals.
An Important MetricCramer's next page in the Wall Street dictionary was all about the different metrics used to value a stock. He explained that when you buy a stock, you're actually buying a small sliver of that company's earnings. By owning a stock, he said, you're betting that either those earnings, or the multiple the market is willing to pay for those earnings, is going up. Cramer said there's no magic to price earnings, or P/E, multiples. The price of stock is equal to its earnings times the multiple. That's it. Of course, both the earnings and the market's multiple on those earnings are always changing, but the formula remains the same. The market is always drawn to growth, said Cramer, that's why faster growing stocks often fetch higher multiples than slower growing ones. To determine how fast a company can grow, Cramer said investors need to dig for clues in its quarterly reports.
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