You have to have a prism to penetrate the stock market. Our goal at Cramer Berkowitz is to look through a prism that excludes the most dangerous stocks, includes the most promising stocks and allows you enough liquidity to be able to move quickly if need be.
The amazing thing about our prism is it has changed completely in the past four years. First, let's talk about the old prism. We cared chiefly about how a stock was positioned relative to the mean. We were looking for stocks that might sell at a cheaper multiple to earnings than the market but that grew faster than the market. Or we were looking for stocks, chiefly financials, but also cyclicals, that sold at absurdly low levels to true book value, betting that the value would be brought out through either stock repurchases or acquisitions by other companies.
To find these stocks, we would look through screens, read annual reports and watch insider-buying patterns. Often we would come across them by going to conferences, but just as often we would come across them by talking to analysts. Once we were in the stocks, we cared passionately about whether they would meet the expectations of the Street on the bottom line, the so-called whisper number. If they didn't, we would freak out like everyone else, but because we fundamentally believed in the company, we might stick around and buy more when others were panicking because we would understand the screw-up and conceivably value it as an opportunity.
The new prism is entirely different. When we say the "fundamentals" in the new prism, we are not talking about earnings per share or whisper numbers. We are looking at revenue growth and orders. When
number came out yesterday, we didn't care nearly as much about the bottom line as about the top line and the orders.
We want to see growth. We no longer care whether the earnings per share is above or below the mean of the market. We don't care because when we do, we end up missing all of the best stocks.
A case in point is bio vs. pharma. The old prism works perfectly for the big pharmaceuticals, but they generate no capital gains anymore (in case you haven't noticed). But try using the old prism on biotech and you strike out entirely. We haven't yet been able to adopt our current prism to biotech, because revenue growth isn't as important as trials. These stocks seem to us to be selling on potential size of market per drug vs. established companies' market capitalizations. One of the things I am trying to divine out of our
biotech rotisserie league is an apples-to-apples way to compare these companies, which is another way of saying, I am looking for a prism that works to identify winners.
(We did not use stocks under $500 million in market cap because we feared the
Hymowitz effect, where we would move the stocks to nobody's good, including our own.)
Understand that for tech, our prism now includes a couple of items that we simply could not have cared less about in the old days. We care about lockup expirations because when
lockup expired, the stock went from 58 to 14, and we can't have that happen to us. We care about secondaries because sometimes the secondaries mark a level of distribution that a stock can't handle. Case in point: The secondary in
has made that stock so heavy that it doesn't have the snap we need to get back in. We care about -- oh mercy -- the chart, because many of the big funds now care about the charts. They probably always cared, but now that the pure fundamentalists are retiring, they are more out of the closet about it. And we have brought in a head trader who cares passionately about the charts -- just as my wife did when she ran our firm's trading desk.
Is one prism more or less rigorous than the other? I don't think so. I used to. I always felt that we had replaced science with alchemy when we shifted prisms. I loved the lovey blanket of the P/E and the sanctity of book value. But what good is a prism that consistently keeps you out of winners and keeps you in losers?
In the end, this business comes down to one thing: money. Can you make it for people, or can't you? You may have a long-term approach for your money, but the people whose money you run just don't. They will take it from you if your prism produces low or abysmal returns. And they will give it to the guy with the better prism.
Is that fair? Is that just? Is that kind? Nah, it's just business.
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at