Book Reviews

Book Review: Jim Cramer’s Real Money by James J. Cramer

Rating: Not bad

Background: I actually listened to the audiobook version (read by the author) instead of the reading the actual book. I had initially thought that Cramer was just some crazy hedge fund speculator-type, until I listened to the audiobook, and found him to be not that bad after all, and is pretty much a fundamentals guy. He has some interesting points to learn from in this book.

Key Points:

  1. “Buy and homework”, not “Buy and hold”
  2. Build in speculation as part of diversification. Speculation is essential to making it big.
  3. 3 points from Andy Beyer’s Picking Winners (a horse-racing book)
    • If you learn from mistakes you will not repeat them.
    • Only invest in stocks where the research and information flow aren’t perfect and lots of minds aren’t already trying to figure it out.
    • Only bet in situations where you have total conviction. Leave the rest to others; you don’t have to play. You don’t have to invest in everything that comes down the pike.
  4. How Stocks are Meant to be Traded
    • Don’t let your cost basis affect you, the future is all that mattered.
    • Always use limit orders.
    • Wall street only cares about the growth of the future earnings stream. Analysts calculated the P/E and the growth rate, then match it against the P/E and growth rate of the S&P500 to determine if it is “fairly valued” vs the S&P. However, behind that piece of paper, there is a real business throwing off cash. Wall Streeters care about growth; Main Streeters care about enterprise value and how much it would cost to buy the whole company.
  5. Investing Basics
    • Diversification is the only free lunch. Diversify against bear markets, company fraud, sector meltdowns, etc. – minimum of five.
    • Do your homework
      • Read the local paper online, every analyst report, the quarterlies, the annuals, every important article, listen to all the conference calls.
      • Know the metric for your industry that measures how a company is doing vs its peers. E.g. cable industry (enterprise value per subscriber), hotels (average revenue per room), airlines (average revenue per seat), retail (same-store-sales), restaurants (same-store-sales), technology (gross margin per product sold), financials (net interest margin).
      • Make sure the business is financially sound (without a lot of debt).
      • The upside and downside are created by two different cohorts. The value guys create the bottom (at a P/E = growth rate); the growth guys create the top (at a P/E = 2*growth rate).
  6. Spotting Stock Moves before They Happen
    •  Two logical catalysts for traditional moves of large caps
      • Rotational catalysts – switching by portfolio managers between secular growth stories and cyclical blastoffs.
      • Estimate revision catalysts – rise in companies’ estimates, change in product cycles, demand cycles.
    • For discovered stocks – sector analysis and specific company analysis each explain about 50% of the moves.
    • There are only 2 ways for the stock price to go up – either earnings increases or the P/E multiple increases.
    • Playing with Multiples
      • If the Fed cuts rates, it will stimulate the economy and cause multiple expansion. People are willing to pay a higher multiple now because they anticipate higher earnings in the future (i.e. in the future, the P/E can be the average P/E but the earnings is substantially higher).
      • If the economy downshifts, the multiple will drop in anticipation of lower earnings in the future.
      • The P/E multiple of all sectors respond to the macro picture, so it is important to stay focused on where you think the economy is headed.
      • Cyclical stocks (e.g. Maytag, Dow Chemical, DuPont) must be purchased when the M is highest (i.e. E is lowest, at the bottom of the economic cycle), and sold when M is lowest (i.e. E is highest, at the top of the economic cycle).
      • Non-cyclicals (e.g. P&G, General Mills, Colgate, Coke, Pepsi) must be bought when their M is lowest (i.e. at top of economic cycle), and sold when M is highest (i.e. at bottom of economic cycle).
    • Playing with Earnings
      • Anticipate spending cycles.
        • Airline cycles – Notoriously cyclical with a “7 fat years and 7 lean years” cycle. When Boeing sees a cyclical upturn in its order book, load up on stocks that make parts for Boeing (e.g. Fairchild – screws, BEA Aerospeace – seats, Honeywell – cockpit instruments). Start to sell when the analysts catch on.
        • Semiconductor equipment cycles – When semicon companies start to do well and buy equipment, load up on stocks of Applied Material, KLA-Tencor, Kulicke & Soffa, and Novellus.
        • Telco equipment cycle – Nortels, Lucents, JDS Uniphases.
    • Focus on interest rates
      • Lower rates lowers the cost of buying stocks, and increases the price (i.e. PV) that you are willing to pay for future earnings. Same thing in reverse for higher rates. (i.e. lower rates -> higher P/E, higher rates -> lower P/E).
      • Recognise when inflation is picking up, move ahead of the Fed.
    • Game breakers
      • Look for undiscovered companies. Identify a sexy concept: e.g. nanotechnology, video-on-demand, homeland security devices, low-carb food, etc.
      • In the initial stages, look for companies with revenues, decent bloodlines for management, scientific prospects that sound legitimate (read trade journals, newspaper and magazine articles, academic studies).
      • Search for companies involved, go in if you are early enough (i.e. NY firms have not yet covered them). Own as much of them as you can.
      • Hold the stocks until the analysts at major firms start their promotion.
      • Get out when underwriting after underwriting occurs as the group goes higher and higher.
      • Ingredients for a mass-psychology-driven move upward
        • 40% management – salability of the story, credibility of management, accessibility of information on the company.
        • 30% fundamentals – cash-flow growth, earnings growth/potential, balance sheet, liquidity.
        • 15% technicals – stock momuntum, support levels, simple charts.
        • 15% “thestreet alpha factor” – stock float, low volume relative to float, how the stock has reacted to strong news in the past, short interest ratio. Like to screen for stocks that have minimum of 100,000 shares, $100 million in market cap, price between $1 – $15.
  7. Stock-picking Rules to Live By
    • Ten Commandments of Trading
      1. Never turn a trade into an investment – declare upfront whether its a trade or investment. If its a trade, after the “event”, get out immediately.
      2. Your first loss is your best loss – cut your losses quickly.
      3. Its okay to take a loss when you already have one.
      4. Never turn a trading gain into an investment loss.
      5. Tips are for waiters.
      6. You don’t have a profit until you sell.
      7. Control losses; winners take care of themselves.
      8. Don’t fear missing anything.
      9. Don’t trade headlines.
      10. Don’t trade flow (i.e. when you see multiple uptrades or downtrades).
    • Twenty-Five Investment Rules to Live By
      1. Bulls and bears make money; pigs get slaughtered.
      2. Its okay to pay the taxes.
      3. Don’t buy all at once; arrogance is a sin.
      4. Look for broken stocks, not broken companies.
      5. Diversification is the only free lunch.
      6. Buy and homework, not buy and hold.
      7. No one ever made a dime by panicking – don’t sell in a panic! typically, the panic comes at the end of the sell-off, not the beginning or even the middle.
      8. Own the best of breed; its worth it – the cheaper underdog hardly ever wins in the game.
      9. He who defends everything defends nothing, or why discipline trumps conviction – don’t try to buy all the stocks that you like, only defend (i.e. average down) good stocks and let the others go.  You need to rank your stocks.
      10. The fundamentals must be good in takeovers – if the fundamentals are bad, the potential acquirers won’t like it either.
      11. Don’t own too many stocks – 5 stocks.
      12. Cash and sitting on the sidelines are fine alternatives.
      13. No woulda shoulda coulda – don’t keep the mental baggage of a screw-up.
      14. Expect corrections; don’t be afraid of them – don’t panic and sell.
      15. Don’t forget bonds.
      16. Never subsidize losers with winners.
      17. Hope is not part of the equation.
      18. Be flexible.
      19. When high-level people quit a company, something is wrong.
      20. Patience is a virtue – giving up on value is a sin.
      21. Just because someone says it on TV doesn’t make it so.
      22. Always wait 30 days after an earnings pre-announcement before you buy – don’t go in immediately after a stock gets hammered by an earnings shortfall pre-announcement; its typically a precursor of worse things.
      23. Never underestimate the Wall Street promotion machine.
      24. Be able to explain your stock picks to someone else.
      25. There is always a bull market somewhere.
  8. Creating your Discretionary Portfolio
    • A stock of a company from your neighbourhood, something that you know or can relate to.
    • An oil stock – some of the most consistent performers with high-dividend yields, great cash flows, and businessess that do well in times of tension.
    • A brand-name blue chip with a 2.5% yield or greater – the above average yield (vs the S&P) will afford you protection if the stock gets hit.
    • A financial.
    • A speculative stock.
    • A soft-goods secular growth stock when it is out of fashion.
    • A high-quality cyclical stock when the economy is at a bottom.
    • A tech stock with a dividend yield.
    • A young retailer that is on a march to national status.
    • A “hope for the future” non-tech stock, e.g. biotech company or something from S&P 600 mid-cap index.
  9. Spotting Bottoms in Stocks
    • Market sentiment (for market)
      1. The pain makes the front page of the New York Times.
      2. The Investors Intelligence survey of money managers (found among the indictors in the Investor’s Business Daily available every Thurs morning) show a bull-bear ratio with less than 40% bulls (i.e. more bears).
      3. Mutual fund withdrawals occuring steadily for at least 2 months. Numbers available on Fridays through an organization call AMG, and almost always in the papers Saturday or Monday.
      4. A reading of +35 or more on the VIX for 3 weeks.
      5. A -7 reading on Helene Meisler’s oscillator on
    • Capitulation (for market)
      1. A dramatic imbalance in the number of new highs to new lows (should have between 400-700 new lows and only a handful of new highs).
      2. No more forced selling by margin clerks from 1.30-2.30pm. When there is no strong sell-off by 2.30pm, its a sign that margin debt has shrunk to acceptable levels and speculation has been flushed out of the system. You can also wait until the SEC releases the monthly margin debt numbers to see radical decline in margin buying (no more hopefuls).
      3. Dramatic spike in volume on the exchanges to indicate that many sellers are cleaned up.
      4. When you are at Stage 5 of the stock market underwriting cyle (see below):
        1. Overheated underwriting market with crazy openings and tons of offering per week -> developing top so get ready to sell alot of stock.
        2. Soon, you have deals opening up unchanged, with little or no premium -> market is sated so be in a minimum of equities.
        3. Then, deals just fail from the moment they come out -> sign of weakness but don’t buy yet.
        4. Then, deal after deal breaks down and the pipeline of new equity dries up -> supply/demand goes out of whack.
        5. One or two months after the flood of new deals ceases, you begin to see a few terrific IPOs and the stocks don’t go down -> buy now!
      5. When you get the “stop trading, order imbalance” sign across the whole stock market, with lots of stocks opening down huge simultaneously on no news.
    • Catalyst (for market)
      • Consider what event could occur that would trigger an “exquisite moment” where a news event that so dwarfs others is about to occur, and the stock market factored in all of the negatives and none of the positives (e.g. Iraq war).
      • After each sell-off, a different trigger will cause the averages to reverse. You don’t  need to know when or what the catalyst is, but you can set yourself up for the ignition.
    • How do you know if you have missed the bottom?
      • The BKX (Bank Index) has been coincident with or has led the market bottom in every case – use as a confirmatory signal.
    • How do you start bottom fishing?
      • Start buying in the morning of the “bottom” with stocks that have additional support from day traders and institutions (e.g. stocks that have been upgraded that morning) – to ‘test waters’ – in case the market drops further, the institutional buying should cushion the downside.
    • Spotting bottoms for stocks
      1. The stock has multiple “sell” ratings.
      2. When bad news hits, the stock ceases to go down.
      3. Consistent large insider buying (need to see large ($M) buys, not small fako buys).
      4. Negative rumors and nothing happens.
    • Other bottoms
      • Sector bottoms due to the Fed cycle
      • Tax-loss bottom – Mutual funds likes to take losses at the end of their fiscal year (mostly in end-Oct). Begin your buying in the last week of Oct, leave some money for the last week of Nov too.
  10. Spotting Tops in Stocks
    1. Competition that appears and hurts the business.
    2. Management starts to be vague with numbers.
    3. Overexpansion and M&A.
    4. Government policy changes with negative impacts.
    5. A retailer that has stores in every state with no new areas in which to expand.
    6. A fad stops. Listen to the conference calls of retailers that sell the fad (e.g. Palm, iPods, etc.)
    7. Company sells stock that is at a huge discount to the last sale of its equity.
    8. Accounting shenanigans.
    9. When the market is red-hot, coupled with an S&P oscillator reading of +5 or more, and there are more than 50% bulls.
  11. Advanced Strategies for Speculators
    • When you know that you have something big (i.e. strong obvious catalyst), either way, the best way to play it is in puts or calls. But if it isn’t big – which is about 99% of the situations – it is better to use the common stock. 
    • When you short a stock that so many other folks are short, and the brokerages can’t find the stock in the vault to lend out, the brokerages go into the open market to find stock to deliver to the buyer, creating a short squeeze – better to use puts.
    • Rules for shorting
      1. Never short a company that could be on the cover of Business Week as the world’s greatest company – i.e. a great company with a short-term screw-up.
      2. Never short a company that can be taken over.
      3. Never short because of valuation – i.e. price is too expensive.
      4. Use puts instead of borrowing and selling short stock.
      5. Never be shorting together with a bunch of people – research must be original.
      6. It is not cool to be short.





  1. Pingback: How to Play a Market Crisis « Journeys of a Bumbling Investor - August 20, 2007

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