Sunday, January 1, 2012

Jim Cramer's Buy and Homework Strategy

CNBC stock market guru Jim Cramer is not a proponent of buy and hold. His strategy involves buy and homework. This method involves buying a stock and then doing your homework to track your investment, to determine when to sell it, buy more, or hold on to it. Homework involves many tactics which include following news stories about the stock, looking at analyst's recommendations, looking at the balance sheet and cash flow statement, listening to conference calls, keeping an eye on competitors, monitoring any changes in management, and seeing if management is buying or selling the stock, and other tasks. Homework takes some time, and Cramer recommends that those who cannot do the homework, should invest in something diversified, like a mutual fund. He recommends taking one hour per week for each stock owned. Mutual funds can be great, but they cannot offer the returns of individual stocks. So, one must determine their tolerance for risk (losing money). Younger investors can afford to take more chances than older investors, since money lost can be gained back over time. If you are in your 20s, take risks. If you are in your 60s, take risks at your own peril. Jim Cramer says to use limit orders, not market orders. That way you lock in a specific buying point for your investment. With a market order, the stock can be bought by the broker at any time during the market day. You might want to buy a stock at 18 and sell it when it goes to 24. A stop loss order can lock in a price where the stock will be sold if it goes too low. You might buy something at 10 and have a stop loss at 8. The only issue with this is, you may miss out on the gain if a stock goes down, then back up. What is you have a stop loss at 8 and then it goes to 12? You have missed out on the gain.

An important formula that Jim Cramer discusses in his books is E x M = P, where E is earning per share, M is the multiple, or price to earnings ratio, and P is the price per share. He talks about evaluating investments based on multiple contraction or expansion. If you know the multiple will go up or down, you can predict the fluctuation in price. His book, Jim Cramer's Real Money talks about rotating investments through different sectors based on anticipating the contraction or expansion of the multiple.

If you want to see the investments in Jim Cramer's charitable trust portfolio, check it out here:

There are some large cap, blue chip stocks here such as American Express and Coca Cola, which are also owned by investing maven Warren Buffett. The buy and hold tactic is practiced by Buffett, and he has done OK for himself. He recommends buying stocks which pay a good dividend, such as Procter and Gamble, Kraft and Johnson and Johnson. View his portfolio here:

The dividend component of stocks can add up to a significant amount of money over time. Especially in tough economic times like we have right now, many play it safe investment wise, turning to dividend paying stocks. Cramer is knowledgeable, but just like with any investment advice, take it with a grain of salt. He is not perfect. Any investor who is perfect is probably that way due to using inside information. I like him since he takes a subject that could be boring (stock picking) and he makes it interesting.

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