This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Cramer's 'Mad Money' Recap: Demystifying Wall Street

Search Jim Cramer's "Mad Money" trading recommendations using our exclusive "Mad Money" Stock Screener.


This show last aired on May 2.

NEW YORK ( TheStreet) -- "Investing isn't easy, but it doesn't have to be mystifying," Jim Cramer told "Mad Money" viewers Friday. He dedicated the entire show to helping translate Wall Street gibberish into plain English for individual investors.

"Secular" and "cyclical" are two important ideas that go hand in hand. Cramer explained that cyclical companies need a strong economy 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 it's 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, he said. Why would anyone want to hold onto a stock that's out of favor? During times of recession investors need to sell the cyclicals and buy into the secular names. When the economy is recovering, it's time to sell the seculars and jump back into the high-growth cyclicals.

An Important Metric

Cramer's next took on 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 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, and that's why faster-growing stocks often fetch higher multiples than slower-growing ones. To determine how fast a company can grow, investors need to dig for clues in its quarterly reports.

Cramer said he's always interested in a company's top-line growth, or how much revenue it generates, as well as its bottom-line profits. He said the markets always pay up for accelerating growth, growth that is speeding up quarter after quarter. Gross margins, the amount of every dollar a company turns into profits, is also another key metric to consider.

Cramer said the only way to truly compare stocks is to look at the multiple, the earnings, the growth rates and how well the top line, bottom line and gross margins are doing.

Risk-Reward

Next on Cramer's agenda, "risk-reward," a term that permeates much of Wall Street. Cramer said this term is nothing more than comparing the possible upside gains of owning a stock against the possible downside risk.

To determine the risk-reward of a stock, Cramer said you need to understand two types of investors -- the growth investors who are willing to pay up for the stock, and the value investors who will swoop in as a stock falls and gets cheaper.

Cramer said the reward is determined by the growth investors, while the downside risk is determined by the value investors. He said one quick and dirty rule is that a stock is cheap if it falls below one times its growth rate, but is too expansive over two times its growth rate.

For example, if a stock trades at 20 times its earnings and it has a 10% growth rate, it probably won't go much higher. But if the same stock falls to a multiple of 10 times earnings, then it probably won't fall much lower.

Cramer said pegging a stock's multiple to its growth rate is a quick and effective tool in determining its risk-reward. You must know what you own, he said, and know what others will pay for it.

Trade vs. Investment

Next, the difference between a trade and an investment. Cramer said that on the surface these terms might seem identical, but in fact they're very distinct.

Cramer explained that when you buy a stock as a trade, you're buying it for a specific short-term catalyst, some anticipated future event that will drive the stock higher. This event may be a company's quarterly earnings, or it may be news driven, like a regulator approving a drug.

In either case, the plan is to buy a stock ahead of the catalyst, and sell it afterward. Once that window closes, however, Cramer said investors must sell their trades, good or bad.

1 of 2

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 17,279.74 +13.75 0.08%
S&P 500 2,010.40 -0.96 -0.05%
NASDAQ 4,579.7890 -13.6380 -0.30%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs