Text copyright © 2013 by J.J. Cramer & Co. From JIM CRAMER'S GET RICH CAREFULLY, reprinted with permission from Blue Rider Press, a member of Penguin Group (USA) LLC
When I started investing I cared only about the fundamentals. And for the longest time that really was about all you should have focused on, beyond some traditional sector analysis. Think about it: we didn't have index funds or sector ETFs; our companies hadn't grown as global as they are now; the government hasn't been this interventionist since FDR and the New Deal; and interest rates didn't affect stocks as instantaneously as they do now. But what a company does and where it fits into the vast economic scheme of things still matters tremendously, even after all of these other influences are gamed. And that means we need to be as shrewd as ever about how to examine fundamental inputs.
The first and most important fundamental influence? The company's growth rate. While a company's past-how much revenue and earnings it has booked historically-can be very important, it's not the most significant factor when we are determining how much to pay for an individual stock at any given moment. What matters is how fast a company's sales and earnings are growing, especially in the context of what is expected of the company. The expectations are set by the analyst community, which is why we have to pay so much attention to the consensus of those expectations. Fortunately, you can find these analysts' aggregate expectations for sales and earnings at a whole host of websites, including CNBC.com, Yahoo! Finance and TheStreet. While I have stated my case that the invisible forces outlined above now tend to dominate the day-to-day pricing of stocks, the ability of an individual company to generate earnings and sales in excess of those expectations remains the biggest factor in trying to figure out if the stock is going to go up or down over both the near and longer term.
At all times we are trying to figure out how fast a company can grow, compared to both all other stocks and the stocks in its sector. We need to know how to assess how a company performs in times of not just domestic but worldwide economic acceleration and deceleration.
Earlier I detailed the notion of cyclical versus secular growth, the growth that is hostage to economic forces and the growth that is dependent upon longer-term themes that don't revolve around the increase or contraction of the gross domestic product. We are always on the lookout for companies that can better both their sector's growth and the economy's growth as a whole. If we can profit from secular-growth companies, that's terrific, but we may have to pay a too-high-to-sleep-at-night price for it. In other words, the price-to-earnings multiple, what we will pay for that stream of future earnings, is higher or more expensive than what we might be willing to pay for a stock with a far more variable, economically dependent earnings stream. That's nothing new. But since the Great Recession, there has been a big change in the price tag of stocks with this kind of consistent growth, because worldwide economic activity has slowed and is now so sporadic that it can't be counted on to produce excessive earnings gains from cyclical stocks. The world has become a much more difficult place for companies to grow earnings consistently. So many economies are now experiencing sluggish, intermittent growth that we treasure any company that can maintain any constant level of growth. Who's got that? Many companies, but the ones I regard as classic growth stocks include Kimberly-Clark, Procter & Gamble, Johnson & Johnson, General Mills, Coca-Cola, PepsiCo, Hershey, Kellogg and Clorox. These stocks are trading at historically high levels because they can deliver consistent, albeit slow, earnings growth in a tepid economy.
On the other hand, if your company's fortunes are linked to the slings and arrows of global or domestic growth, then you have a classic cyclical on your hands, and you need to anticipate any reacceleration or deceleration or both, something that's become exceedingly difficult to monitor. That's why if you own Caterpillar, Ford, General Motors, General Electric or Cummins, the engine company, to name some examples, you have to be on top of world events, particularly in China, pretty much every day.