Understanding the First Part of Jim Cramer's Sane Investing in an Insane World, a primer for the newbie investor
Last summer, we took my son down to school in Florida. At the hotel, I caught a few minutes of what I then thought was the most insane show I had ever seen -- Mad Money. I thought the "guy," who turned out to be Jim Cramer, the "Real Money" guy, was a nut -- a screaming, crazy, raving mad nut who was trying to sell me something. Naturally, I changed the channel. Then, I got mad when my local radio station added him to the middle of the day -- not that it really mattered to me, I'm usually at work then. But something changed this summer: I decided to get serious about my family's finances. And, I decided to listen during that hour. And I started to think, "this guy is absolutely brilliant." Could he help us to invest properly? Could I follow his advice? This is the time for me to do something with our various retirement investments which we've just added to, but never really looked at. So, as I wait to rollover an old account into an IRA, and my husband does the same, I decided to see if I could learn from Jim Cramer about what to do with my money. So, I'm reading his book. I've gotten through the beginning chapters, and I thought I'd share with others who are attempting to fix their own families' financial health, what it is Jim Cramer is trying to teach.
At the outset, let me say, that this is not an easy book, and, although he says up front that he is teaching the novice, I took some classes in investing, and, had I not, I think I would find it even more difficult. As it is, I am not yet understanding all of his principles, but, with some more time and energy, I think I will get it more and more. So, I thought I'd start with a chapter by chapter review of his ideas in my words and based on my understanding. Feel free to chime in with your own thoughts about the "Mad Money" guy -- I am definitely a fan.
Chapter One is mostly motivational and tries to sell people on the idea of getting into the game, i.e., the stock market, and sticking with it. He wants people to see that the stock market can be used to make money that augments our salaries because, for most of us, our salaries alone will not make us rich and they won't exist when we retire. Thus, we need to do something with money to have it earn money if we want the extras that salary will not buy or if we ever want to retire.
Chapter Two is called: Getting Started the Right Way, and does essentially two things: It disposes of three so-called myths of investment strategies and explains what stocks are and how they get publicly traded. The first myth, according to Cramer, is that people should "buy and hold." He says, you should "buy and do homework," because, he also disposes of a second myth that indicates that people should not trade. Buying and doing homework might lead to buying and selling depending on what you learn from your homework, so trading is not always bad. In fact, trading is what might allow you to earn more money than just getting a good stock and keeping it forever. Finally, he says that never speculating is another myth that conservative investors should not buy into. Sometimes, speculating makes sense: it just can't be all of your portfolio and it depends on how smart you are when you decide what to "speculate" on. Despite this advice, he still considers himself conservative, and from listening to him and reading his book, I agree that he tends to be conservative -- he looks for growth and value and good dividend paying stocks. He looks for good companies that are also good buys in the market -- and he demystifies the process of figuring out how to determine value in the next chapter.
That chapter is titled, "How Stocks are Meant to be Traded," and offers a great explanation of Price/Earnings Ratio and a method of determining whether or not you are getting value for the stock in which you are planning to invest. He also says one very important thing that I wished I had learned before I bought my last stock: you do not put in an order to buy or sell and leave it at that. You always should use limit orders, meaning, you tell the person you are trading with to buy at X and sell at Y. Otherwise, your broker, to make more money, can match your buy and sell with a buy and sell within his or her firm, and make commissions on all ends of the sale -- even if you sell for less than the "market" at that moment, or buy for more than the market at that moment. So, you decide on the price you are going to pay -- within a reasonable amount of what the stock is trading at if you want to get the stock. This is a limit order and Cramer says, if you get nothing else out of this book, get this.
The ratio explanation is harder to explain but Price to Earnings Ration, P/E ratio, as many of you know, is simply how much each share sells at in comparison to how much each share earns. When you know that multiple, you can use it as one aspect of your decision to buy or sell a stock. A $5.00 stock can be more expensive than a $50.00 stock because it can be trading at a higher multiple to earnings than the $50.00 stock. More importantly, though, is to figure out the growth of the stock. If the company is growing, than the earnings can be expected to grow; therefore, you can compare two stocks within a sector or against the S&P 500 by figuring out how its P/E is in comparison to expected growth. How can you determine growth: research. The starting place for research according to Cramer is in past growth -- if the company's earnings have been growing, they are likely to continue to grow. But, since that's already built into the price of the stock, most likely, what you want to look for is a stock that may be flying a little under the radar, or improperly valued because the stock is damaged as a result of the economy itself or something that is not an underlying problem with the company. In other words, he advises finding bargain stocks by looking for damaged stocks in good companies. (Cramer explains how to figure out the P/E; however, any stock chart will tell you the current p/e of the stock -- you want to know how to figure out the future price of the stock based on future earnings and what might be the multiple in the future).
Next, in Chapter 4, which is long and fairly complex, Cramer gives some "Investing Basics." First of all, he wants the reader to understand that you should have different strategies for different needs and ages in life. To break it down, an investor must be more cautious with retirement investment strategies than with investing to add to one's income and needs to get progressively more conservative as he or she gets older. With respect to retirement, he recommends that people in their 20's should be in aggressive stocks. By your 30's, you'll want to be moving into dividend paying stocks, or stocks that will pay dividends in the future. In your 40's, add some bonds, ; by the 50's, you need to move more money into fixed income and by the 60's, when you hope to retire, you might want to move most of your money into more fixed income types of investments. In other words, you want to be more careful with money that you will soon be needing to live on.
When it comes to your other savings, you can be more aggressive and more speculative. In fact, he tells people in their 20's that they can have 50% of their portfolio in speculation and you should decrease that by 10% per decade.
Your strategy also includes a huge decision: do you invest yourself or use professional advice. And, when can you begin to invest. Finally, you must have a diverse portfolio. Thus, you must have somewhere in the neighborhood of 5-10 individual stocks and should not start investing until you can have that much -- at least $2500.00 should be available to begin investing in individual stocks. If you are going to manage your own portfolio, Cramer says the homework takes about one hour per week per stock. Thus, you need to see if you like the investing business enough to spend that much time. Otherwise, you'll probably need to rely on a professional.
What does Cramer mean by homework? Company reports (all free and downloadable by the SEC), news articles that can be gotten on many, many web sites, and the company's conference calls, where they explain their basic strategy and what has been going on in the recent past. Research on a company begins before you buy -- you need to know if it is a good, solidly managed company that is growing, whether or not it does or plans to pay dividends, what exactly it sells and whether or not it is a company that is really going to be effected by changes in the economy or is a "sector" stock; something that people need and cannot give up, regardless of the economy, and is not, therefore, likely to be effected by changes in the overall economy. You are looking for a company that grows faster than the average company but sells for a lower multiple than the average company. And, if you want to ensure your money does not get taken away in bankruptcy, look for a company that is not in debt.
Well, that was a mouthful -- I will continue to outline the chapters as I read them, but, in the meantime, this can get you started.