Jim Cramer’s Real Money: Advice to Beginning Investors

This week, The Simple Dollar takes a look at Jim Cramer’s Real Money. Cramer has made a huge name for himself in stock picking punditry and he claims to reveal his methodology in this book. Is it worth reading? Let’s find out.

Much of the early part of the book is focused on advice for beginning individual stock investors, a group that I would include myself in. The advice throughout the book comes at you at a frenetic pace, so here are ten specific pointers that I was able to extract for anyone who is thinking about investing in individual stocks.

Do your homework. Cramer advocates spending one hour per week researching every single individual holding you have. At first, that seems like a lot, but once you start doing it, you find that it’s pretty easy to burn an hour a week reading articles, reading annual reports, reading SEC filings, and listening to conference calls. After a while, you start to get a really good feel for a company and that feel is the most accurate tool you have for where a company is going. If it starts to feel bad, it’s time to sell, but if the stock is dropping and you can’t conceive of a reason, then you should ride it out.

Be willing to speculate. Cramer advocates taking a small portion of your money and using it for pure speculation, something that most pundits consider abhorrent. Basically, Cramer’s logic is that you’ll be tempted to speculate and you’ll punch yourself and do stupid things if you see yourself skipping out on a speculation, so you should use a small fraction of your investment budget on highly speculative investments.

Be conservative with your retirement. At the same time, the book gets very conservative when it comes to retirement savings. This is not where speculation should be happening. Your retirement money is not your “get rich quick” money – it should be invested in mutual funds and bonds, not in individual small cap stocks.

Diversify! Your top five individual holdings should never be in the same industry, or else you’re opening yourself up to a good deal of extra risk. In the 1980s, there was a food stock bubble. In the 1990s, there was a tech stock bubble. There could be another bubble forming right now. If you get greedy and start throwing everything into one sector that seems great, you could take the same ride the NASDAQ took in 2001 – straight to the basement.

Don’t blindly follow analysts. Most analysts are not directly involved in the business of investing in individual stocks. Instead, they’re quite often people at various investment houses who have the time to write articles for public consumption. In other words, be aware of what analysts are saying, but don’t follow what they’re saying blindly.

Never trade at market value, use limit orders instead. If you see a stock at a price you like, don’t merely buy that stock or else you’re going to find yourself buying high. Issue a limit order instead. For example, if you see WHR at a hair over 86, instead of just saying that you want to buy 50 shares of Whirlpool, instead issue a limit order for 50 shares of Whirlpool at 86. If you don’t do this, you’ll get a price that you probably won’t like for the sale.

Every company and industry has a key metric. For example, most clothing producers have a key metric of warehouse inventory; it’s good to have some warehouse inventory, but if it keeps going up period over period, there’s something wrong with the company. It takes research to figure out what this metric is and it can take even more to find that metric for a lot of companies in the industry, but it is invaluable at helping you figure out how things are going in the industry.

When comparing stock prices within the same sector, ignore the actual price and compare the price-to-earnings ratio. For example, I love Lowe’s (LOW) and their most obvious competitor is Home Depot (HD). LOW currently has a P/E of 16.44, while HD has a P/E of 13.70, even though the share price of Home Depot is higher. If the other numbers of the two companies are comparable, then HD is a much better buy than LOW.

Use earnings growth as a second comparison between two stocks in the same sector. If one company has a very low P/E ratio compared to the competition, yet their earnings growth looks good, you should start studying that company, because the market is probably undervaluing the company. On the other hand, a high P/E ratio without much earnings growth indicates a stock that’s not going to be leaping (unless there’s something unhealthy going on).

You only need $2,500 to start. Cramer says that all you need to get started is $2,500 – a portfolio of five diverse stocks with $500 in each stock. What stocks? Tomorrow, I’ll discuss Cramer’s advice on five stocks you should start with for a portfolio – and five more that you can buy to build a larger portfolio.

Jim Cramer’s Real Money is the twelfth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

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