Cramer's 'Mad Money' Recap: What Moves Stocks

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NEW YORK ( TheStreet) -- A company and its stock aren't the same thing, Jim Cramer told "Mad Money" viewers Wednesday. He dedicated the show to educating investors as to how stocks really work and what makes them move.

Cramer said it's easy to assume a company and its stock are synonymous, but that's simply not the case. While over the long haul winning companies usually produce winning stocks, it would be irrational to think the two will move in lockstep with each other. There are, after all, tons of factors that can make a stock fall, many of which have little to do with the performance at the company itself.

One of those factors has been the rise of exchange-traded funds as an easy means for investors to gain exposure to an entire sector. Cramer said ETFs, many of which buy and sell with leverage, have the effect of moving an entire sector all at once, taking the good companies along with the bad and even the mediocre. This means a stock's sector has become even more important than in years past.

High-frequency trading is another factor that causes stocks to move in ways you might not expect, said Cramer. These nimble investors can hijack an entire market and cause explosive moves both to the upside and the downside.

Then there are the issues of hedge funds and short-sellers causing volatility. Cramer said when a lot of shorts pile into a stock and something good happens, the move to the upside can be mind boggling.

Markets are, after all, dominated by supply and demand, said Cramer. Once investors realize that, they will become better-informed investors.

Do Your Homework

So with stocks moving for so many different and sometimes arbitrary reasons, why should investors spend time researching and doing homework on their stocks? Isn't it all just a waste of time? Absolutely not, said Cramer.

All investors need an edge and homework can provide one, said Cramer, especially in a market where many investors panic and sell at the drop of a hat. Having done your homework and having conviction in the stocks you own will remove emotion from the equation and help you buy when others are selling.

The fundamentals matter now more than ever. Best of all, the information about how a company is doing is readily available and perfectly legal. Being familiar with a company and how it's doing is not an all-or-nothing game, said Cramer. Even knowing a little bit can still give an investor a leg up on many others.

If something changes, how will you know whether to cut your losses or double down? Only homework can answer that question. Homework is not always a guarantee of immediate gains but it is still one of the best weapons investors have in their arsenal.

Know Your IPO

Cramer's next lesson about what makes stocks move dealt with newly minted stocks and how to navigate the volatile IPO market. He said it's impossible to ignore the quick 20%, 30% or even 100% gains that can be had in days, or sometimes minutes, from investing in IPOs. But these stocks can also carry a lot of risk as well.

The fact is, there's a lot of hype surrounding most IPOs, said Cramer, which is why many of them fizzle after their first day of trading. Facebook ( FB) is a clear example of a company that came nowhere near close to living up to its first-day hype.

Don't let brokers tell you that every IPO is a great one, Cramer warned, because some issues are just not worth investing in. But sometimes the investment banks that bring stocks public have a secret agenda, bringing investors back to the market and rewarding their most loyal clients.

IPOs are, after all, about supply and demand, said Cramer, which is often why banks will limit the number of shares being offered to help engineer that first-day pop to the upside. They want to make sure their clients are able to make money, he said, which is why IPOs such as those of LinkedIn ( LNKD) and Groupon ( GRPN) were priced lower than they probably could have been given the demand for shares.

Investors who use a full-service broker and can get some shares of these under-priced deals should do so, said Cramer, but investors should never buy shares in the open market after the IPO because the inflated prices are rarely able to hold up for the long run.

Read the Fine Print

Just because a company's stock is coming public doesn't mean it should be, Cramer warned, which is why knowing how to research a coming IPO is more important than ever. What should investors be looking for in the prospectus? Cramer said he looks at everything including the company's management, its investors and which brokerage firms are bringing it public.

When it comes to management, Cramer said it's likely investors will have never heard of those at the helm. That's OK, he said, especially for tech companies. Nobody knew who Sergey Brin of Google ( GOOG) or Mark Zuckerberg of Facebook were before their IPOs, but those companies seem to be doing OK, he added.

Next, Cramer said he looks at the company's investors. He said to be leery of companies with large private equity shareholders as they are often eager to cash out on the same IPO that they're enticing you to buy into. If firms have indicated they're investing for the long term, that's a good sign as they'll be right there with you.

Finally, Cramer said he wants to know which brokerages are bringing a deal public. Some, he said, are better than others and have a reputation for doing right by investors. Firms like Goldman Sachs ( GS), Cramer's alma mater, won't stake their reputations on a questionable IPO, while a smaller, lesser-known firm might.

What Do They Do?

Cramer's last step to investing in a coming IPO is to analyze the company itself. What does it actually do? Is it profitable? How big are its end markets? Cramer said all of these are questions that investors need to ask.

For some companies, especially consumer ones such as apparel companies or retailers, it's pretty easy to figure out what they do and how well they're doing it. But for others, including complicated technology or biotech firms, this may be a more daunting task.

But Cramer said a company with large end-markets, one that's profitable and one that's got a great brokerage behind it is what he calls thrice-blessed and has lots of room to run.

Lululemon Athletica ( LULU) was one such company, he said. The yoga-based apparel maker was tapping into a huge market, was already profitable and had Goldman Sachs behind it. He said this stock continued to grow, even in the tough times of 2008 and 2009, because of its huge potential.

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-- Written by Scott Rutt in Washington, D.C.

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At the time of publication, Cramer's Action Alerts PLUS had a position in GS.

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