Jim Cramer's Stay Mad for Life

by James J Cramer

  After what seemed to be myriad negative stories, I gave in and blew the stock out in the low $40s. Soon afterward the company and the FDA began to get their arms around the story: there were probably no more than two hundred cases and they were treatable. The stock began to move upward and the company got a takeover bid for more than $70 soon after. I had succumbed to the media’s assertions of dire forecasts for B&L because of this one small product line. There were a host of businesses that were doing quite well for B&L, and though other companies grabbed some share, its core franchise was strong enough to withstand this recall and this negative publicity. By the way, the same reporters who kept hammering this story home never reported on the conclusion of the scare. It didn’t matter; the opportunity to buy from those scared by the media was long gone. The money had already been made by others.

  A second case of brutal media coverage came at the expense of Bristol-Myers. This fine company, with a host of truly great medicines, including some of the very best cancer drugs, had a very important heart drug, Plavix, under patent. Because of some quirk with a Canadian company, Apotex, management had somehow let a generic version come out without enforcing its contract. Consequently the drug, responsible for a good deal of the company’s profits, was momentarily blitzed by a huge amount of generic pills before Apotex could be stopped. The media focused endlessly on the patent loss, harping on how Bristol-Myers was in huge trouble. The reality is that BMY had a strong franchise. If you believed in these media reports, you would have thought that all BMY had was Plavix.

  Two quarters after the generic drug worked through the system, Plavix pricing went back to its premium level because the generics did violate BMY’s patents. Plus, BMY applied for and introduced exciting new cancer drugs. Soon the stock rallied to $32. Too late for me, as I was stampeded out of it at $23, down $3 from where I had bought it. I was caught up in the media frenzy and didn’t believe in my own homework. Of course, no one in the media regarded this momentary blip as a buying opportunity, which is exactly what it was.

  Or how about Cephalon, a biotech company with a host of excellent, profitable products, including Sparlon? Cephalon had developed what looked to be a terrific product for attention-deficit disorder. It was important for the company that Sparlon be approved as a way to augment the 2009 earnings for the company. But when Sparlon came before the FDA, there was a high-stakes drama because a couple of patients in a study encompassing more than a thousand people had come down with Stevens Johnson syndrome, a rare skin disease that could be fatal if not detected. Because the disorder Sparlon was meant to combat was not life-threatening, this side effect was considered to be too negative to allow the drug to be approved. I had bought the stock in the $60s and it had run to the $70s on the possibility of Sparlon approval. That didn’t happen, and the stock got crushed to the $50s. At that price it was absurdly valued compared to the rest of its product line.

  But the stakes had been so high and the media coverage so vociferous that it obscured everything else that the company was doing right. I succumbed to the focus and dumped the stock in the $50s. Eighteen months later the stock had reached the mid-$80s as the rest of the product line just kept chugging along. I had been spooked by the media into thinking that Cephalon was a one-trick pony and the pony had come up lame. It was just the opposite: another buying opportunity because of a strong, stable product line. I can’t tell you how often an FDA hearing seems make-or-break for a company. And it has been for true one-product companies like Dendreon with its Provenge prostate-cancer vaccine. But the opposite is true most of the time: there are many drugs humming in a diversified pharmaceutical company, including biotech companies, and it pays to remember that when the sound and the fury are focused on one product. Think of B&L, Bristol-Myers, and Cephalon before you succumb to the media’s drumbeat against one of the drugs in what may be a strong breadth of products. That way you will realize what might be a time to buy, not to sell.

  I hope these twenty lessons, gleaned from the many glaring mistakes I’ve made while running a public fund, will help you to avoid similar consequences. I don’t want to imply for a minute that these stocks wrecked the performance of those who followed my recommendations. (Remember that my actions are restricted and some of the prices in these stories are lower than they would have been for my readers, who could have gotten out sooner as I apprise readers of my moves ahead of time.) Nonetheless, unlike the trading mistakes I describe in my other books, you can see that these bloopers are, in many ways, patterns that may be familiar to you or patterns you might not even realize yet. Just so you know, I spotted them in two ways that could help you. First, I went over every trade and bulletin I had issued over the life of the trust. Second, I also looked at the trust’s holdings in snapshot fashion, meaning I looked at the portfolio as a whole every quarter and at the end of every quarter. I didn’t do it to torture myself; I did it to remind myself that many heat-of-battle decisions have been wrong. Many positions would have worked out well in the end, but most important, many times I had let others disturb my thinking about what would have been sound decisions otherwise. Know thyself. You are better than almost anyone out there at picking your stocks. Rely on your stocks with my lessons, and I bet you will beat the market handily over time—perhaps becoming richer than you’ve imagined in your wildest dreams.

  7

  WHAT THE PROS DO RIGHT AND THE AMATEURS DO WRONG

  Not long ago my good friend James Altucher started the first social networking stock site. It’s a terrific place, Stockpickr.com, where professionals and amateurs gather every day to noodle on what to do next and what is happening in the market. It is also a great place to learn. But not just for home gamers anxious to pick up experience and lessons; for people like me too. Every day when I go into the “Answers” section of the site, I see questions addressed to me that show the tremendous gulf between amateurs and professionals, a gulf so great that, unless I do my best to help ameliorate it, will simply grow wider and wider, with beginners losing money repeatedly and even seasoned investors getting blown out because they don’t understand what is happening and they don’t know how to put aside their amateurish acts because they’ve never been taught by the pros. I have been a pro for three decades, but that doesn’t mean it wasn’t a continuing education course from the moment I got to Goldman Sachs to the moment I went on my own to start one of the first hedge funds. I never thought I would say that, but in retrospect it was a pretty gutsy thing to leave the friendly confines of Goldman to strike out on my own. It worked, but being a professional was something that didn’t come second nature to me and won’t to you either. So what can we do? After culling all the differences between what I see amateurs do routinely on Stockpickr.com and what I have been taught to do, I thought it might be a good idea to bridge the gulf right here and now by showing you the distances between us on a list of ten divides, and then giving you the tools to close them yourself.

  Here are things the pros do right that amateurs insist on doing wrong when they manage their money:

  Ten Things Pros Do Right but Amateurs Get Wrong

  1. Pros always have cash. Amateurs are always fully invested. One of the most painful lessons I have learned is that when you run out of cash, you are truly in trouble. I always, always always keep cash around when I am running my trust, and if I ever find myself without 5 percent in cash, I consider that running on empty. This concept is alien to almost all of the amateur investors I have ever met. I can’t tell you how many times I have responded to questioners with suggestions that they buy more of their favorite stocks and they say they are “fully invested,” with no more cash on the sidelines. There’s a simple reason for that: nonprofessionals think it is right to be fully invested. When I was a professional investor I was probably fully invested only after gigantic declines in the market. My rule of thumb was that unless you had a 10 percent decline, peak to trough, you should have cash on the sidelines ready to put to work, preferably as much as 10 percent,
maybe more after a big run in the market. Yet I always see people and hear from people with no reserve.

  How strongly do I feel about the need to keep the cash, not for a rainy day but for a monsoon? Even in my own 401(k) I don’t commit all at once. I commit one-twelfth of my annual allocation a month, changing my behavior and putting the rest in, only on a 10 percent decline. If I don’t get a 10 percent decline, I will have committed the money on my regular one-twelfth-a-month schedule. What can you do to ensure that you will have cash for those great opportunities? And believe me, having that cash will be the difference between staying even with the averages and trouncing them. I want you to consider the cash you have to put to work like the gas in your car. Would you ever consider running it on empty? Don’t you always like to have at least an eighth of a tank of gasoline? That’s what I want you to do with your stock money. If you can fill ’er up there, that’s fabulous. But if you can’t, sell something you don’t like as much as what you do like, or sell something to buy something better. Unless the market’s down 10 percent, consider yourself fully invested until a huge decline occurs, and then you will be able to have a shopping list ready. When I write in Real Money or on Stockpickr.com or when I say on my TV program that it is time to get your shopping list ready, you won’t be mad at me. You will be grateful. Oh, and by the way, if you are even tempted to use margin—borrow money from your broker—and if you are even contemplating a home equity loan for stocks, please go recycle this book; I wasted good paper on you.

  2. Pros learn to start living and stop worrying about the quarterly report. Don’t base buys on quarters—avoid them. And don’t buy during earnings season. That’s too hard. “Jim,” the queries always begin, “do you like Intel ahead of the quarter tomorrow?” To which I say now, because I am no longer a hedge fund manager, “I think I like Intel every day but the day before the quarter.” The pressure nonprofessionals put themselves under trying to trade quarterly reports is unbelievable. They take these totally unfathomable moments to put the gun to their head and pull the trigger.

  You should know some things that have happened in the past decade. Every company tries to report at pretty much the same time. Because of Regulation Fair Disclosure, no one can contact a company during the quarter to see how it is doing, which was formerly standard practice and was part of an investor’s homework. This regulation made being an amateur an impossible hurdle to overcome. We are all equal now in the eyes of the law, so you can’t get an edge. That means you have to listen to the conference call, match the expectations—what analysts were looking for—with what the company did, and then make a judgment. There are hundreds of people listening to these calls or to their replays and playing out this exercise. Then the analyst community scrutinizes the quarters and pronounces judgment. All this is happening at lightning speed because there are usually a dozen companies’ calls that people might be interested in all taking place at the same time. I don’t care how dedicated you are, how smart you are, how plugged in you are—this kind of rapid-fire moment does not lend itself to smart thinking. And you know what? It can be proved.

  I sat down and looked at the periods when companies reported and saw how stocks did compared to when they don’t report. The three weeks after the end of every quarter that companies report is almost always the time period when the least amount of money is made and the most is lost. That’s why many of the professionals I know, including the best ones, have chosen simply not to buy anything during this period. They want to see the news, they want to retreat to their offices, they want to make decisions after everyone reacts, and they want to do it all on their own time with no pressure. Only amateurs pressure themselves. Professionals remove the pressure, remove the noise, and make decisions at their own pace. Will it cost them occasionally not to get in front of a good quarter? Of course. But it is much better to do the work on the quarter, watch and listen, and then pounce when the market gives you that break. You don’t have to take action. I don’t want you taking action. I want you to make your decisions with as many facts as are available after the quarter, when everything there is to know is known. That answer is always disappointing to those who want to make the quick trade. But I want the bigger bucks, and the biggest bucks cannot be made betting on the direction of a given quarter. After all, if the company is that good, this won’t be its last good quarter.

  3. Pros try not to invest in things they don’t know. They are not anxious to risk their hard-earned capital on something that sounds cool. Taking passes is the best thing I do. So many people ask me about different stocks, but many stocks are beyond my ken. I just recognize they are not my strength. I am a generalist who takes pride in knowing more stocks than anyone in the universe. Hardly a day goes by when someone doesn’t ask me about some stock that has a miniaturization method, a nanotech derivative. I know better. I recommended one, Tessera Technologies, and the week after my recommendation it lost 20 percent of its value on something that, frankly, I simply did not understand, some piece of technology that was just too hard to know unless you were using it as a client. Same thing goes for a lot of the wide-area network stocks—stocks that help remote workers tie in with headquarters. These are jargon-filled black holes that you need an information technology expert to walk you through. Lots of the biotech stocks leave me cold; I don’t understand how the medicines they make are special or different and how the companies themselves can be sure that they work. I also never think I can get an edge in commodities, even though so many people want me to tell them what I think of the direction of wheat or corn or soybeans—yes, I actually get asked that. I just accept the fact that I don’t know it, that it is too hard for me to learn, and I take a pass. Too many people feel embarrassed to take a pass. Not me. I am always willing to say, “Nope, I don’t get it, I don’t understand it, and I don’t want to trade it.” Don’t think that everything has to be traded or owned. Some things are genuinely too hard for you to know. In Magnum Force, Clint Eastwood summed it up well: “A man’s got to know his own limitations.” I know mine. Do you know yours?

  4. Pros recognize that not everything is analyzable. Amateurs think that everything can be explained, graded, and traded. Not that long ago, a persistent questioner on Stockpickr.com kept asking me about a company called Clean Energy. He would not let up. Finally I told him it was not analyzable. That wasn’t enough. He said that the legendary oilman T. Boone Pickens owned a big piece and he wouldn’t do that if he couldn’t analyze it. I told him I didn’t know anything about why T. Boone Pickens liked anything but I did know that the company didn’t file financials and it based its so-called earnings on the amount of natural gas it pumped into gas tanks. I kid you not! That was the metric. You couldn’t even tell what the darned revenues were, let alone the earnings. Sorry, I think it’s irresponsible to invest in something like that. This lesson is quite different from knowing your own limitations. There isn’t anyone in the world, including T. Boone Pickens, who can make sense of that stock.

  Tons of people call in to my show and ask me about Chinese stocks. Again, the financials are not only often opaque, they are often nonexistent. I can’t tell a thing about them. I also am a firm believer that if you can’t figure out what a particular bond is, such as a collateralized debt obligation that batches mortgages into a bond, you should never even be invested in a fund that has this junk. I believe that no one should own a fixed-income instrument or be in any hedge fund or mutual fund that owns something that can’t be priced online from a Web service. The bonds that wiped out so many hedge funds and some banks were unanalyzable and unquotable. No one even knew what they were worth. And that’s the bottom line: if you can’t figure out what something is worth, if you can’t compare it or match it to something else because you can’t understand the financials or don’t know where it is trading, forget about it.

  I will leave you with a story. Recently, a very nice man who had read all my books stopped me in a card store and wanted to know what I thought about a ce
rtain Chinese airport stock. He said it was going great guns and that I should look into it. I did. There wasn’t even a fact sheet on the thing, just a name of a stock, an address in China, and a price, around $1.50. Sure, maybe it could go up. But checking it out was impossible. If you can’t check out a stock, which means listening to the conference call, making sense of the filings, reading the releases, and comparing it to other stocks, forget about it. That’s the basic information you need to make a decision. Without that, you just don’t have enough to act on.

  5. Pros want to know the downside, not the upside. That’s why dividends and buybacks are so important. Whenever I meet or am in contact with a nonprofessional and I am pressed for an opinion, I always turn the tables and ask, “How much do you think this stock can go down?” People don’t want to know that. They just want to know how much it can go up, or they want to tell me how much it can go up. They never want to hear about the downside. They don’t even think it will go down. I think that everything will go down, everything. I always want to know what can cushion me. How big is the buyback? Is it a genuine buyback that shrinks the float? (A “buyback” is when a company purchases its own shares, reducing the number of shares on the market and thus making each share more valuable as it represents a slightly larger piece of the company. The “float” is the number of shares that actively trade on the market.) Or is it one of those bogus buybacks that retires some of the stock the company is issuing to employees? Is the dividend good? Can they pay out more? Is it possible that, even though the dividend seems small as expressed by the yield (dividing the stock price by the amount of the dividend), it may be bountiful if we think of it is as a moving target?