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Editor's note: This recap was last published on Dec. 27, 2011.
NEW YORK (
) -- "You can make more money investing for yourself than you would investing in bonds or index funds," Jim Cramer reminded his
viewers Friday, devoting the entire show to helping home gamers become better investors.
Cramer said ordinary people can become great investors, even if the pundits and market "experts" say otherwise.
Cramer's first lesson for investors is that the market isn't always rational and it doesn't always make sense. Sometimes we try to find logic and reason where there is none. "The market does some crazy things," he explained, "and when that happens, you want to take advantage of it."
On days when the markets get pummeled, Cramer said there will be tons of stocks that go down for bad reasons. He said that hedge funds, for example, sometimes need to sell their positions to raise cash to meet margin requirements or redemptions. When this happens, stocks don't move on their individual fundamentals but on the fundamentals of the money management business.
Cramer said the worst thing an investor can do is assume that because a stock trades at a certain level it deserves to be there. "Was it right for oil to trade at $147 a barrel in 2008?" Of course not, he said. With so many hedge funds gravitating toward the futures markets, "hedge funds gone wild" are having a greater impact on how the overall markets react.
The next time everything goes down all at once, Cramer told viewers, don't cook up reasons to justify it, just ask yourself if you might be seeing out-of-control hedge funds taking charge.
Buying Broken Stocks
"Buy broken stocks, not broken companies," was Cramer's second lesson to investors. In a serious correction, everything will go down, he said, including a lot of stocks that don't deserve to. But how can investors tell the difference?
Cramer said every correction has a cause. In 2008, it was mortgage-backed bonds while in 2011 it was the debate over the debt ceiling and the resulting U.S. debt downgrade. Cramer said investors can look for the companies responsible for the corrections and assume they're probably broken companies.
In 2008 that meant banks and everything associated with housing and mortgages were bad. In 2011 it meant any company that would suffer big in another economic slowdown was to be avoided.
Cramer reminded viewers that a company only becomes broken when the reason for liking it goes away, not when the stock price goes lower. The latter case, he said, is a buying opportunity, while the former are the toxic companies that must be avoided at all costs.
Cramer's third lesson for investors was an outline of which types of stocks he looks for in a big market pullback.
Cramer said he first looks for stocks that have recently pulled back from their highs. He said stocks on the 52-week-high list don't get there by accident and while these names are often seen as expensive, they're probably worth it.
Occasionally, a stock will fall from the 52-week-high list for a good reason, such as a missed quarter, but more often it will take a big market correction to rattle these high-fliers. Those are the names Cramer said investors should look for.
Second on Cramer's list are stocks with high dividends. Dividend stocks aren't sexy like high-growth tech stocks, but in a downturn dividends play an important role. They act as a cushion underneath a falling stock because as the stock price falls, the dividend yield -- the amount the company pays as a percentage of your investment -- goes higher. This makes dividend stocks more attractive the more its price declines.
Cramer said his rule of thumb for determining whether a company has a safe dividend that's not at risk of being cut is whether that company earns more than twice the amount of its dividend. If a company's earnings can pay for its dividend twice over, investors probably have a winner.
Caveat on Buybacks
Cramer's next lesson: buybacks. Stock buybacks, which are programs where companies buy back their own shares to reduce the share count and thereby boost earnings per share, used to be regarded as a winning strategy, he said.
In fact, between 2005 and 2011, companies in the
Standard & Poor's 500
spent $2.24 trillion buying back stock, significantly more than the $1.4 trillion spent on dividends.
Unfortunately, Cramer said, these programs have not created the value investors thought they would. He said the track record since 2009 is getting better, but it's still hard to find companies that didn't squander their money buying shares at higher prices only to see them sink even further.
Cramer said HMOs like
are among the worst offenders. He said these companies kept dividends small and bought back shares. Yet, the buybacks did nothing to lift share prices and the billions of dollars would have been better spent on dividends.
Cramer said the notion that buybacks help cushion a stock's collapse is false. When the panic starts, the remaining shares will fall just as hard as a larger amount of shares would, he said. In 2008, banks were very active in buying back shares, only to see them plummet towards oblivion.
Cramer said buybacks by themselves are no reason to own a stock, and in some cases could be a reason to sell it. "They are a false sign of health," he concluded, "and are too often a waste of shareholders' money."
Putting Money to Work
Cramer's final thoughts for investors involved fuel -- not for your car, but the kind that makes stocks go higher after a big decline.
Cramer said the fuel that stocks run on is investors taking their money off the sidelines and putting it back to work. When money is flowing into the markets, mutual funds start buying and whole market gets lifted. He noted that it's easy to find groups that can go higher when money's coming in just as companies are turning themselves around. Investors need to buy on the dips each time they occur in these situations, he said.
But in the reverse case, when panic is sending money out of the markets, that's when investors need to be cautious, said Cramer. He said there will still be groups that are rising, but without new money flowing into the markets these moves come at the expense of other sectors.
That's why investors will typically see defensive stocks such as
heading higher when the market declines, as money moves out of other sectors and into these safer names. But Cramer noted these moves are not sustainable unless the retail investor has signaled the "all clear" by putting more money back to work.
--Written by Scott Rutt in Washington, D.C.
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At the time of publication, Cramer's Action Alerts PLUS had a no positions in the stocks mentioned.
Jim Cramer, host of the CNBC television program "Mad Money," is a Markets Commentator for TheStreet.com, Inc., and CNBC, and a director and co-founder of TheStreet.com. All opinions expressed by Mr. Cramer on "Mad Money" are his own and do not reflect the opinions of TheStreet.com or its affiliates, or CNBC, NBC UNIVERSAL or their parent company or affiliates. Mr. Cramer's opinions are based upon information he considers to be reliable, but neither TheStreet.com, nor CNBC, nor either of their affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Mr. Cramer's statements are based on his opinions at the time statements are made, and are subject to change without notice. No part of Mr. Cramer's compensation from CNBC or TheStreet.com is related to the specific opinions expressed by him on "Mad Money."
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