Cramer's 'Mad Money' Recap: Demystifying Wall Street
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, or 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.
Next on Cramer's agenda is the term "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 cohorts of investors -- the growth investors, or those willing to pay up for the stock, and the value investors, or those 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 time 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. InvestmentCramer's next jargon item: the difference between a trade and an investment. He said 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 U.S. Food and Drug Administration drug approval. In either case, the plan is to buy a stock ahead of the catalyst and sell it afterward. Once that window passes, however, Cramer said investors must sell their trades, good or bad.
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