Transcripts For CNBC Mad Money 20130807

Stocks that are worth owning, that i believe will reward you be either going higher or paying you juicy dividends or often both. But perhaps because of my four decades in the business, i sometimes leave way too much unsaid and take too much knowledge for granted. Knowledge you need to know to be the best investor you can be. So tonight, im taking time out to impart some of that knowledge in a special show about the way stocks really work and how they interrelate or dont with the companies they stand for and are supposed to represent. On mad money, we analyze companies, trying to figure out what makes them tick. What should we be watching for . What goals theyre supposed to meet . What expectations are supposed to be . But we dont trade these companies, we invest in their stocks. And you should never forget that the company and their stock are not the same thing. I know, sounds pretty obvious, the kind of thing that should go without saying, but people constantly make the mistake of equating a company with its stock. And its the kind of mistake and its the kind of mistake that can absolutely wreck your portfolio, especially in volatile markets like these, where many stocks do tradeoff on bigpicture socalled macrodata about the broader global economy, instead of whats known as the micro. Macro still rules. When its good, they go higher. When its bad, they go lower. Its all too easy to assume that a company and its stocks are synonymous. We see this all the time. A stock gets pulverized, we assume something must be wrong with the underlying company. Why else would the stock be why else would the stock be pounded. Or on the flip side, when a stock surges, we assume the company has been doing something special, something right. Thats simply not how markets work, people. Often, shares of a companys stock will have big moves, up or down, for reasons that have absolutely nothing to do with the underlying business. Thats okay. Happens all the time. And it doesnt mean the market is crazy or irrational. But whats irrational is believing there will always be a straight line, a lock step between the performance of a company and performance of a stock. There would be no mad money if there were. Isnt that the way the market should work when it isnt broken . Dont we spend lots of time on this show, doing homework, analyzing companies, showing you how to figure out what makes some businesses better than others, teaching you how to identify situations where companies are improving, or at least doing better than people think . Im always telling you the most important determinant of a higher stock price is increases in earnings estimates for the underlying company. That nothing correlates more strongly than the rise in share price than estimate increases. Although, increasingly, i equate future success with dividend boosts of decent magnitude. So why isnt it enough . Why isnt it enough just to Study Companies and buy the stocks of the ones that look like they have the most and can grow earnings faster than expected. Why isnt it enough to just invest in the homework and close your eyes . Because we cant buy companies unless youve got hundreds of millions of dollars to throw around. Its simply not an option. Instead, we have to buy shares of stock in those companies. Shares of stock. Shares that trade on an open market, where you have lots of buyers and sellers, who might have very different motivations from you. So when you find a highquality company with seemingly excellent prospects, you cant just assume that shares of the company will go higher, since you also need to take into account the stock, the way the stock trades, the way it trades in the market, up and down. Dont get me wrong here. Over the long haul, the best way to pick winning stocks is by identifying winning companies. Ones that are growing faster than anyone expects or vastly increases their dividends, or are improving dramatically. I mean, im not changing my mantra one bit. That is still the way to go. But, lots of times you call me on a daytoday basis, it doesnt work. These stocks on a daytoday basis can trade wildly with no relation to whats happening at the company and those movements may be confounding, so confounding that you sell low or buy high or give up entirely. And you know i think you need to stay in the game if youre going to augment that paycheck and save money for retirement, for vacation, for tuition, all the necessities of life. If you assume that every move in the stock market makes sense vis a vis the underlying business, youre going to end up passing up some incredible opportunities to buy merchandise thats been marked down for irrational reasons, and you know what, youll miss when you should sell stocks that have run up too much, courtesy of market mechanics. Sell, sell, sell. Rather than anything related to the company. In recent years, weve witnessed the rise of a ton of factors that can cause a stocks performance to differ even more radically from the performance of the underlying company. At least in the nearterm. Over the longterm, of course, you know, they do tend to converge, but over days, weeks, maybe even months, you have all sorts of things that can make the stock of an improving company fall, or the stock of a deteriorating company rise. These days, many investors say you use Exchange Traded funds, etfs, to get exposure to entire sectors. Some of these etfs allow them to buy or sell with a ton of leverage, giving them double or triple buying bang for their buck. This proliferation of etfs means that some stocks in the sector can trade in lockstep with each other. The good moving in complete tandem with the bad, and a business sector has always been an important determinant of a stocks performance. If a stock is a house, then its sector is the neighborhood. And nobody wants a good house in a lousy neighborhood. The house of pain. The house of pleasure. But these days, the influence of these etfs i think has become noxious, pernicious even, for those of us trying to discern the wheat from the chaff, and have made this sector more important than ever when it comes to the daytoday action in the stock, too important. Plus, you have the highfrequency traders who can hijack an entire market, causing massive acrosstheboard moves that make no sense from the fundamentals from the perspective of the fundamentals, especially at moments of extreme volatility. These new waves all distort the stockpicking beaches we know from the flash crash and other shortterm blips down. And when times get tough for companies, they can get much tougher for their stocks. I talked about the problem of forced selling, the idea that stocks can get slammed just because hedge funds that own them are in trouble, and they desperately need to sell, sell, sell in order to raise cash. You see this when a bunch of hedge funds make the same bet. You saw it in the banks a couple years ago, saw it in gold recently. And if things dont go their way, Money Managers will bet heavily on euro zone. They didnt have to sell their european assets. They had to sell everything had to sell totally unrelated and stocks too because they got hurt so bad. Especially if their investors were clamoring to get their money back. By the way, this is exactly what happened when we crashed in 2008 and 2009, when selling begat forced selling, which ultimately took most stocks down to absurdly cheap levels, back at that generational low in march of 2009. The reverse happened in 2012, when those who bet against european stocks, almost all stocks, but particularly the financials, had their heads handed to them when the European Central bank put its foot down on the short sellers necks and made money all over the place. The bank stocks soared. It didnt matter whether it was a bank was solvent or insolvent. They all flew up together. I know that you probably have never shorted a stock, but in an investing world that is now dominated by hedge funds, most of which have to make bets for and against whole stocks and whole markets every day, their influence must be taken to account when we try to figure out how a stock can differ from the company underneath. When lots of shorts pile into a stock and then get hit with some unexpected piece of good news from the company, you can get whats known as a short squeeze, that propels the stock to the absurd heights since short sellers have to buy to admit defeat. A lot of people feel thats what happened to tesla, okay, that elon musk company. Remember, the market is, well, a market. Which means its dominated by supply and demand. So when theres not enough supply of a given stock or kind of stock to satisfy that demand, you could see a stock rise beyond what youd expect based on the fundamentals of the company. And when theres too much supply of stock relative to demand, then shares get hammered, well beyond where you might have thought they could go. We saw a lot of this with the super hot areas like the chinese i hot internet ipos in 2010 and 2011. At first these deals were staggering. They give you this incredible performance. Everyone got so excited, they just wanted nothing but china but the gains became smaller and smaller and smaller as we got more and more chinese dotcoms coming public. Ultimately, they flooded the market with their supply, the same thing that happened, by the way, at the end of our dotcom boom more than a decade remember, at the turn of the century. And with the deluge of social media ipos in 2011 and 2012, we saw it again. In the end, no chinese deal was worth participating as the supply was just way too heavy and demand well oversaturated. This is one of the reasons why the chinese ipos reached their lowest level in a decade. 83 decline from 2011, 90 decline in 2010. And the buyers of the last social Media Companies out of the chute, as we call it, the groupons and zyngas, they were crushed by waves of insider bailing, seemingly at any price imaginable. Super hot stocks became super cold ones, simply because the public was first fascinated and then turned on them with a vengeance that i havent seen since 2001. Of course, the fundamentals were never any good to begin, but, boy, did they have buzz. So the bottom line, recognize that whats happening with your stocks doesnt always necessarily reflect whats going on with the underlying business. And when a company thats in terrific shape sees their stocks smashed, that could be an amazing buying opportunity. Just remember that it can sometimes take a long time for the action in a stock to sync up with the performance of a company it represents a tiny piece of. That way you wont be frustrated with what you thought should happen immediately after you heard fabulous news, and instead you can wait until the market gets smart and rewards your stock with the move it deserves. Lets go to dave in virginia, please. Dave . Caller yes, how are you today, jim . Im real good, dave. How about you . Caller im doing real well. I had a question for you about aftermarket trading. I was curious what exactly is it . Who gets to participate in it, and what are the ups and downs of it . Okay. Anybody can participate. I mean, if you have a broker that allows you to buy and sell, the market doesnt really close anymore at 4 00. Theres bids and there are offers. I dont like it. I dont like it because its unregulated, so to speak. Theres not really a lot of depth to the market. You can end up buying something too high and selling it too low. I dont encourage it. I encourage homework, no snap judgments. Stay away. Jay in texas. Jay . Caller hey, booyah, jim booyah. Caller jay from south texas. How are you . Caller just fine, thank you. Question i have for you, jim, is if theres some distribution in the stock throughout the day, meaning more sellers than buyers, how is it many times the stock can defy gravity and close up for the day . Well, i mean, the sellers do sometimes complete, and while the sellers are selling, buyers are buyers get lined up by brokers who say, listen, ive got a big seller, ive got a big seller. What happens is the stock goes down, and then when the final piece trades, all these buyers converge, and they end up overwhelming that last piece and the stock goes higher. Thats what happens time and time again. Look, sometimes the stocks performance doesnt match the companys underlying business. I know that can shock you, and it can take a while for the two to sync up. But if you get a bargain, please, be patient. Wait. Your rewards will beckon. Mad money will be right back. Announcer dont miss a second of mad money. Follow jimcramer on twitter. Have a question . Tweet cramer, madtweets. Send jim an email to madmoney cnbc. Com or give us a call at 1800743cnbc. Miss something . Head to madmoney. Cnbc. Com. [ kitt ] you know whats impressive . A talking car. But ill tell you what impresses me. A talking train. This ge locomotive can tell you exactly where it is, what its carrying, while using less fuel. Delivering whatever the world needs, when it needs it. After all, whats the point of talking if you dont have something important to say . Since aflac is helping with his expenses while he cant work, he can focus on his recovery. He doesnt have to worry so much about his mortgage, groceries, or even gas bills. Kick kick. Feel it feel it feel it nice work you got it you got it yes aflacs gonna help take care of his expenses. And us. Were gonna get him back in fighting shape. [ male announcer ] see whats happening behind the scenes at aflac. Com. Welcome back to tonights special edition of mad money, where im trying to explain what really moves stocks. Now, they often diverge from the fundamentals of the companies they purport to represent. I know this is something that confuses you mightily. I read your email, i see it, jimcramer on twitter, i know this bothers you immensely. You need to know a little more about the traders who drive stocks in Different Directions and you need to watch shortterm moves in stock prices. But to take advantage of them, rather than pretending like so many pundits do, that these shortterm gyrations in stock prices are beneath their notice and will somehow pollute your gains. May we never be so selfimportant or arrogant around here as to think that entry and exit points dont matter. They often control the ability to outperform the market, they certainly control how much money we make, they affect our profit margins. We care more about prices at the supermarket sometimes than we do about the prices of the stocks we buy. Thats plain wrong how do we square the idea that when you buy a stock, its price can become unglued from the underlying fundamentals about the company . The facts about the business, my insistence, how do you balance that with my insistence you always do your homework and keep track of the fundamentals by listening to quarterly Conference Calls and the myriad of information on the web to keep current with the company. You think stock prices will just bounce around anyway, if theyre offered at the mercy of socalled macro factors. Or if their stock will be held hostage by big institutions like hedge funds that trade them, why am i giving you this relentless focus on learning, learning as much as you can about the underlying company. Why, especially given that homework is by far the most onerous and least interesting part of the process of the process of investing. The reason we focus on the fundamentals is just about anyone who tries to understand can actually do it. A lot of its arithmetic. The information is all public and all readily available. In short, why you may think the homework is tedious and boring, its also easy compared to trying to predict so much of whats out there that simply is unknowable. Investors are always looking for an edge, looking for some kind of leg up that provides them with an advantage over everybody else. That will never change. Not all advantages are of the same scale. But just by following my standard homework regimen, you should have a edge over most of the other people who trade the stocks you follow. How on earth is that possible . Your homework involves looking at publicly available information. Anyone can check it out. According to some economists and most armchair investors, the very fact the information is out there means it should already be baked into the stock. Meaning the share prices should reflect what you know from your research, but we know thats just not how the market really works. Lots of people are real lazy. Lots of Money Managers are technicians, which means they dont get down into the nittygritty of the Quarterly Earnings Conference Calls. If you keep up with this information, youll know more about a stock than most of the professionals do, although theyll never admit that. And if thats not an edge, i dont know what it is. Homework is about taking control of your financial destiny, eliminating as much emotion as possible. Thats why i focus on it. I know ill get results. The very objective kind that doesnt fall prey to fears about a fiscal cliff that might be irrelevant, a sequester to your stock worries, or a Federal Reserve minutes that dont mean a thing to your position. Maybe the homework will always give you that much of an edge. Wont give you enough information to tell you which direction a stock will ultimately head. Maybe it wont protect you from the whims of the children in washington, d. C. , who play with the economy willynilly, or the debt issue thats always going to be affecting any number of rogue nations in europe or our own country. But learning about companies isnt an all or nothing proposition. I dont think familiarizing yourself with a company should ever be dismissed as less than useful just because it doesnt immediately translate into immediate profit. And remember, ultimately, as i said at the top of this special show, stocks do tend to drift back into line with where they deserve. They do sink, ultimately. Given how the Underlying Companies are doing. So in addition to knowing a lot of pertinent things about a business, you can also assume that your stock will probably end up within a certain price range, but youve got to wait long, got to let it percolate. On top of that, as long as you keep up with the homework, you have a good, clean way of deciding whether or not to cut your losses in a stock that isnt working, and thats an incredibly valuable tool, especially when youre trying to claw your way back, if your stock went down because of a typical market selloff. You need to know enough to figure out whether you should perhaps be a buyer if nothings going wrong with a company. You need to know whether opportunitys really knocking, or is your head about to be knocked to the canvas. And on the other hand, it will give you the conviction to stay in a good stock thats been hammered by the market for wrong reasons. Either way, you will always know why youre buying or selling something. You wont be beholden to anyone but yourself when it comes to your investing decisions, and you can just think over time, how many stocks have dropped, you know, just because of a quick decline, and you wished you had bought them, but you didnt know the fundamentals, so you couldnt. The better you are at avoiding stocks with a risk reward that is changing from bad to good or good to bad, the better positions youre going to be able to make. Youll be able to make more calculated, intelligent risks and be more aggressive with your investments. These skills are useful no matter what, but they are of paramount importance when it comes to investing in stocks. The tension between needing to protect your capital and risking that capital in order to make money. But even though these skills are handy, they arent what most people would call compelling and they may not give you the total picture you may need to get to where you need to go. And as for the boredom factor, let me take care of that. I spent years trying to make investing more accessible, more interesting. No sin given that so many will focus on scaring you out of your shoes. And i think ive shown i will do anything to keep investors engaged with their money. Ive come out on the set and filmed while wearing a hazmat suit to compare hasbro to mattel. Ive taken a nap on a bed of cheerios, driven on to my set on a lawn mower to intrigue you to look into john deere. I cant figure out how many dollars worth of expensive gizmos ive wrecked. Ive shed blood on the set to try to show you the inside of a boeing, and chipped my tooth for krispy kreme. And i also ate pepperoni dog food and threw up on the set soon after the show concluded. So i am not concerned that too many of you will skip the homework because you lack the proper motivation, interest, or enthusiasm. Believe me, i will make this stuff entertaining for you no matter what. We have ways of making you motivated. The bottom line is it is important for you to know why youre doing all this work, what the point is. Its is a way for you to build conviction in your stocks. Its a way to get an edge, one thats totally legal, even in the most volatile or calm of markets. In an era where so many panic at the sight of the president coming up to a podium or the speaker of the house giving a press conference, you need to know that it might be a buying opportunity and not just a selling one like the panickers all around you. [ male announcer ] come to the golden opportunity sales event to experience the precision handling of the lexus performance vehicles, including the gs and allnew is. This is the pursuit of perfection. [ male announcer ] the parking lot helps by letting us know whos coming. The carts keep everyone on the right track. The power tools introduce themselves. All the bits and bulbs keep themselves stocked. And the doors even handle the checkout so we can work on that thing thats stuck in the thing. [ female announcer ] today, cisco is connecting the internet of everything. So everyone goes home happy. But you had to leave right now, would you go . Man oh i cant go tonight woman i cant. hero thats what expedia asked me. Host book the flight but you have to go right now. Hero laughs and i just go . This is for real right . This is for real . I always said one day id go to china, just never thought itd be today. Anncr were giving away a trip every day. Download the expedia app and your next trip could be on us. Expedia, find yours. And experience the connectivity of the available lexus enform, including the es and rx. This is the pursuit of perfection. I want to tell you about a tool that can help you make money quickly, but also carries a certain amount of risk and can be trouble if you dont know what youre doing. Investing in initial Public Offerings, ipos. Its impossible to ignore the ipo opportunities that have presented themselves in the last couple of years. Theres been so many deals, including many that have gone to a premium and are red hot from the moment they are born, and others that fizzle from the opening bell. These are led, in particular, by technology and social media names, which have been met with exceptional hype and not enough skepticism. Hype doesnt even begin to describe the buzz, almost hysteria around that facebook ipo. That was super hype, or maybe hyper hype, for a company that indeed has some excellent longterm prospects. Sure, ipos are sexy. They are talked and written about endlessly. But youre hardly ever told what to actually do with them. Ill teach you the basics right now, because when you know how to tell the difference between an about to be Public Company that will soar and one that could go down in flames, you will then have the potential to rake in some serious profits. The lure of ipos is that when you nail it, when you get in on the right one, you know what, you can have gains of 20, 30, even 100 in a day, in a few minutes time. The instantaneous nature of these profits makes them incredibly attractive, but they can also often get in the way of your better judgment and cause you to invest in initial Public Offerings that end up stinking up the room. As helpful as those profits can be, dont let the brokers trick you into believing that buying every ipo is a great way to make money and the real challenge is just making sure your broker can always finagle you some shares. Wrong, wrong, wrong. In fact, some ipos arent worth investing in at all. The Investment Bankers will always try to slip in some clunkers. Partially because of the performance of newly Public Offerings tends to be all over the map, especially their first day of trading, and partially because there simply isnt that much available information about ipos beyond that prospectus that very few people read, there is a tendency to assume that the success or failure of a given ipo is mostly a question of luck, and that is also wrong. I think you can accurately try to figure out which ipos to write off as uninvestable and which ones deserve to be bought. You can separate the ipo wheat from the chaff. It isnt about luck, its about analysis. The kind of homework that professional Money Managers do all the time and the kind i advocate tirelessly on the show. I would analyze stocks back the same way at my Old Hedge Fund and thats the way i still do it. I made a boatload of money a for myself and for my clients at my Old Hedge Fund by investing in ipos. I think the investment banks that underwrite all these deals have their own agenda, one that i believe is often as much about bringing people, regular people, regular Retail Investors, like you, back into the game, as it is about helping their clients raise money in the equity markets. One of the things i learned on my many years on wall street, both hawking stocks and bonds at Goldman Sachs, and managing money for myself and for the rich people in my hedge fund, when the market turns south, when it becomes really difficult to make money, and people start pulling out the money from stocks all together, you know what those brokers like to do . They like to throw investors some easy wins, some layup ipos that are intentionally underpriced so they will pop when the shares start trading. Why do i think they would underprice the deal and shortchange their Investment Banking clients . Because its just as important to the brokers that their other clients, the ones that pay them commission, keep them interested in the market. And for most investors, the gains from a sweet, underpriced ipo, or offerings with a small float that boosts shares are a great reason to feel good about being in the stock market, about owning stocks, about buying stocks. When times are tough, the brokers want to entice you back into the stock market. Hey, come on, that makes a lot of sense, right . Theyve got to figure out ways, because their business depends on you buying and the investor selling. And by the way, the companies dont mind this, as long as not too much stock is given away too low. So for the anatomy of ipos that fit this pattern, i need you to look at linkedin, didnt issue a lot of stock, and groupon, which priced in 2011 and rose 109 and 31 respectively in their first day of trading. Theres no doubt that these offers signaled talks about a bubble of internet stocks, but there was also no doubt that the issue was the artificial way that they were priced, putting out very little stock, a sliver, knowing that it would cause a big pop, and creating a bubble all by itself. The brokers knew these stocks would be hot, in part because of the valuations floating around for social media and hype for the group. They also knew that if they offered a limited number of shares and set the pricing below the hyped valuation levels, demand would overwhelm supply. Even though these were wellknown companies, the brokers tightly controlled the supply, parceled it to accounts they believed would not flip the stock, and gave out just enough to the large mutual funds that they would be able to start, but not finish, their outsized positions. Thats way the mutual fund appetites would be whetted, they would come into the secondary market, the regular stock market after the stock opens, and bid, bid linkedin up and get the rest of their positions in, and thats why linkedin kept soaring. Never forget that the trick to a successful ipo is this rationing process. The Syndicate Desk, theyre the ones that allocate the stock to potential shareholders, they know how much the big mutual funds ultimately need to be able to have enough linkedin to impact their own performance. So what the Syndicate Desk does is they give them a percentage, usually about a third, sometimes half of what they need to own, what is known as half of a full position, and that forces the clients hands to complete the size of that position in the open market. Now, of course, they could flip the position themselves, but brokers have ways to monitor who takes that quick money, and they may not be allowed to get big allocations the next time around. You benefit, though, because the Syndicate Desk almost always saves some stock for Retail Investors, as the brokers know that Retail Investors are more likely to hold on to stock and not play that flipper game. You know what, i am actually indifferent to whether you do either. My goal, try to help you make money. The one thing i dont think you should do, though, ever, is go into the aftermarket and buy stock. Were going to miss some opportunities, but thats okay. Listen to me. I dont want you to go into the aftermarket, meaning i dont want you to buy the new ipo on the open market after it started trading, particularly at inflated valuation levels. Just forget about it. Ive got staggering statistics that show you that you are almost always a sure loser if you buy a hot stock after a couple trades, most just gigantic losers that could destroy your nest egg. Sure, linkedin, total longterm winner. But groupon still remains in the doghouse, as do so many of the shooting stars of that now bygone era. The odds favor losing and not making money in aftermarket investing in ipos. You have to just trust me on that. Ive done the work. You are in a much better position than that of a mutual fund. You dont need to buy a lot of stock well above the offering price, you can pick and choose provided you do enough business with a fullservice broker. In the aftermarket, wait until you get a reasonable entry price, right, and then performance details before coming in, okay . Like with facebook in the fall of 2012. When everyone feared that there would be a ton of insider selling, just at the time when the company got religion about going mobile, that was the time to buy, not sell, as the weakest hands were already gone, knowledgeable people jumped in to do some buying. Heres the bottom line. Ipos can be a great way to make mad money, but if you are not in the know, it can be a very treacherous path. So keep these ipo mechanics in mind, and remember that the big guys do not necessarily have you, the home gamer, in mind. So beware and trust me. Never, ever buy in the aftermarket. For every one winner, there are ten losers. Dont be a sucker. Stay with cramer. Clients are always learning more to make their money do more. ann to help me plan my next move, i take scottrades free, inbranch seminars. Plus, their live webinars. I use daily market commentary to improve my strategy. And my local scottrade Office Guides my learning every step of the way. Because they know i dont trade like everybody. I trade like me. Im with scottrade. announcer scottrade. Ranked highest in Customer Loyalty for brokerage and investment companies. [ male announcer ] you wait all year for summer. This summer was definitely worth the wait. Summers best event from cadillac. Let summer try and pass you by. Lease this allnew cadillac ats for around 299 per month or purchase for 0 apr for 60 months. Come in now for the best offers of the model year. Dealing with ipos can be difficult and dangerous, because the prospect of instant gains is so enticing, the euphoria can cloud your better judgment, as everyone who got in on the aborted facebook deal knows all too well. Thats why you need a consistent method to make sure you dont get torn to pieces by something that you dont understand, a deal you cant fathom, or make heads or tails of. So heres your primer on analyzing smoking hot deals and icecold deals, the safer and the dangerous. The first and most important thing i look for with an ipo isnt what the company does, believe it or not, its the company pedigree. Yes, the bloodlines. I care about who the executives are, who the investors are, but most important, who the brokers doing the deals are. The first cohort, the managers, can often be a relatively unknown group of people. Strangely, its actually the least important part of the pedigree, education. Heres why. Its very interesting. Many of the best deals represent technology companies, including social media, and those companies revolve around an invention, much more than a management team. Look, if you just looked at googles management team, for example, you would have avoided this ipo like the plague. I mean, think about it, who the heck were larry paige and sergey brin . They were a couple of 20something wild men. Thats not particularly encouraging, is it . But those relative new kids on the block have proven themselves and bet on the new, young innovators is that they will too. Do you know more about mark zuckerberg, other than he wore a hoodie and had a movie about his struggles with those two tall guys . My second check, who are the investors . More of a negative check, a disqualifier, if you will, than a positive one. When looking at the investors in the company thats coming public, im concerned about you getting caught up in another kind of investment, one that is funded by private Equity Companies that are simply anxious to cash in on a better market. Private equity firms like blackstone, kkr, carlyle, cerberus, they have bought dozens of companies in the last few years. In many cases, they paid far too much for them. They badly need to offload these companies into whats known as the open market, so they can get them off the books. Some of them will barely be profitable, others will be stinkers that the brokers will try to entice you to pick up with a hope that a rising tide can lift all boats. The way i see it, these private equity ipos, almost as a rule, are difficult to judge. Im not being that pejorative. Some will work, but theyre difficult. And this brings up another important aspect of analyzing ipos, recognize that just because a company can be publicly traded, that doesnt mean it cant be a piece of junk. There are plenty of publicly traded companies that will qualify as a travesty, a mockery, a sham. Some of the smaller social media names fit this category. The regulators dont have a mandate to judge the quality of the business of ipos, they just make companies disclose as many facts and financials as possible, so you can judge yourself as home. And the brokers, at least when theyre dealing with the private equity firms, theyve got a bit of a conflict going there, because they do so much business with these outfits that theyre hard to say no to. The brokers houses get immense amounts of money from private equity firms when they take a company private, and even more fees when theyre spun off as a Public Entity again. Including large fees for the fixed income fees. They refinance like you do at home. Thats why the Investment Bankers will bend over backwards to favor the private equity firm. So if you see that private equity firms are Main Investors in companies coming public, lets call it a yellow flag. It would be a red flag if theres been a lot of bad deals. And third, i always look at the brokerage houses bringing the deal. This is really important. I want them to be major firms, yes, you may not like them, but along the lines of a morgan stanley, a Goldman Sachs, a credit suisse, a jpmorgan. Why does this matter . I know you dont believe me, but these firms have their reputation on the line with that deal, and that makes them less likely to bring a clunker public just for the fees. You can often take the brokerage name underwriting the deal as a fairly good seal of approval for the enterprise. Dont be all that jaded, people. I know many are, and its wrong. Why do i think this . Let me tell you a story. In the 1980s, as a young broker at the Goldman Sachs, i had personally helped work with the finances of the people behind a Young Company started by some Brilliant Inventors out of m. I. T. , called the thinking machines. They claimed they had the fastest computer in the land. I remember dow jones used it, it was so good for their back office and stuff. I had done so much work with the principals that when they decided to bring the company public, i was actually able to convince them to use Goldman Sachs as their deal manager. It was a big plum. There was only one problem. I couldnt convince Goldman Sachs to put its name on the deal, despite the immense fees that an ipo brings to a firm. The analyst at the time who followed the company for Goldman Sachs, he pored over the financials, he looked at the product and he made a judgment. He made a judgment that the company, while having shortterm momentum, most definitely, would not have any staying power. I was aghast. Oh, man, i was looking at a big payday. I stood to make a big sixfigure ticket for bringing the deal to Goldman Sachs. This analyst, though, he simply wouldnt budge reminding me that this was Goldman Sachs, not some schlock firm that put its name on any company just because it was hot. Sure enough, we passed. And a couple years, the company failed. A victim of Better Technology and poor financial management. The house of pain. So take it from me, thats why the brokers pedigree matters and i would pass on deals done by firms that you have never heard of or that have little or no track record with successful underwriting. Doesnt mean that every ipo brought by Goldman Sachs would be a success, far from it. But in the heyday of social media, just like with the dotcoms at the turn of the century, every firm, good and bad, got caught up. So there are never any assurances in an overheated market, but checking the names behind a deal remains integral to a good ipo. Now, look, nothings perfect. Thats why i have a checklist. Hopefully one of these will flag you. Heres the bottom line. Only after ive gone through that threestep vetting process would i then actually consider what the company does, or what it makes. Or how it has done in the past. In part because its so difficult to judge these issues. And i would rather use the quick filter i just went through before i even crack the books on a company. Something ill teach you how to do after the break. Ve to ask yoo power down your little word game. I think your friends will understand. Oh. No, its actually my geico app. See . I just uh paid my bill. Did you really . From the plane . Yeah, i can manage my policy, get roadside assistance, pretty much access geico 24 7. Sounds a little too good to be true sir. Ill believe that when pigs fly. Ok, did she seriously just say that . Geico. Just a click away with our free mobile app. A body at rest tends to stay at rest. 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The new blackberry q10. Its time. Weve reached the final step how to analyze the Actual Company thats coming public. Here you have to assess what the Company Makes. You have to ask if its profitable. And post important, if youre thinking about hanging on to the stock after the deal, you need to know how big its end markets are. Thats so crucial. This isnt all that different from analyzing any other stock, except you have less information to go on. Most of its coming from the prospectus. Figuring out what the company does can be pretty easy if its got a big brand or Consumer Products business, say under armour or crocs. But it can be very difficult to figure out what the darned Company Makes if it involves a sophisticated product, especially with technology. These technology companies, like those ones connected with broadband or optimization or wide area networking, semiconductor miniaturization, hey, no wonder Warren Buffett says, dont go there. If a company is making thats coming public makes a consumer product, first youve got to ask yourself, is it a product you like . This isnt the only question, but it does matter. Take the ipo years back, a thing called heelies, which made shoes with wheels on it. That is a product i absolutely despised. I predicted it would jump when it came quickly, but then get out quickly. It popped to the 30s, and then began a long decline that took it to as low as a dollar and change a few years later. On the other hand, when the company has a good product, one that you like, when its already profitable and many ipos arent and has solid financials, then you can catch both the gains from the first day, the initial public pop, and then from an extended run afterwards. And thats what happened with the under armour, ua, ipo. That was a truly mouth watering deal where i knew the steak matched the sizzle. On the first day it popped from 12 to 25, but i urged people to take hang on after taking some profits, even at that higher price, under armour was being valued the same as nike, even though it had a much higher growth rate. Thats a classic example of stock market mispricing that worked to your advantage. Once in a while, you get a thrice blessed ipo, a lot of room to run and a great brokage house sponsoring it. Lululemon athletica is a good example. Goldman sachs brought public at 18 in 2007. Its continued to grow despite the selloff because of the gigantic market that was initially just women who performed yoga, but now has extended to all women, not even just women athletes, and some men too. Some of the best ones from 2012 to think about, organic food maker annies, discount youth retailer, five below, fibe, and enterprise software, guide wire, and they all fit the threeprong test. In all of these cases, the trick is to recognize the size of the market, the power of the competitors, and try to figure out how the company is coming public is valued versus similar players. Deals like under armour or lululemon which are priced at significant discounts to their peers when you factor in the growth rates, they tend to be the good ones, but are rare indeed. The bottom line, to analyze an ipo, including the abstruse technology companies, you want to look at the addressable market, the competitors, the historic growth rate of the company, versus the growth rate of the market itself, see whether the company is profitable, make sure of the brokerages pedigree, and then youll know whether its worth it to put in for the deal. Mad money is back after the break. Aaa. Fffffff. Laclaclac. Hes an actor whos known for his voice. But his accident took that away. Thankfully, hes got aflac. Theyre gonna give him cash to help pay his bills so he can just focus on getting better. Were taking it one day at a time. One day at a time. [ male announcer ] see how the ducks lessons are going at aflac. Com well, cramerica, its time for your tweets. First from clarkevans3, who writes the following, why dont more Companies Split the stock . You are so on point here, clark, ive got to tell you. One of the great things about some of the stocks i follow, when they do split the stock, like a salesforce. Com, you get a lot of liquidity. It makes it so the stock doesnt trade so herkyjerky. Cocacola likes to split its stock. The companies that get to 300, 400, they must think theyve got berkshire hathaway. I think they should split it. It doesnt create any value, but it does make it so individuals are much less scared of a stock. And maybe thats enough. No value created, but very proretail. And heres one from tswizelwizzel who writes, advice for a young person, whos the best strategy to go about investing small amounts at a time . Quantity or value . I like to pick stocks that are below ten for my first stock, and buy five shares. That way i get to feel the pain if it goes down, i can always buy a little more if it goes down, and its easier. Only later do i start getting up to stocks, i know it shouldnt even matter what the dollar amount is, but i know the way you think. I know you dont think like a yale professor whos trying to analyze stocks. You think like i did when i started. You want a little bit of capital to be able to buy five shares, thats the way to play it. Another tweet from harrisonfresh. And this one says, diversified amongst Asset Classes or with just stocks. Which should i be most concerned with . Booyah, nor cal. Okay, heres what i care about. I care about baskets. It can be etfs. I like individual stocks. But you have to think about what they do. I care about the end market. Thats why i do diversification. If everybodys end market has to do with finance, or everybodys end market has to do with technology, then you end up being hurt. So consider who the customer is, if youre unsure about whether theyre diversified. The next tweet comes to us from pgallagher3115. Whats the best investment book youve read . One up on wall street, beat the street, peter lynch books, really terrific and i think theyre great places to get started. Lets go to one from jehamilton. How many hours do you sleep each night . I tend to get between three or four hours of sleep each night, except for friday night and saturday night, where i get about twice that. I believe you actually save up the sleep. If you get a lot of sleep on saturday night, you dont need to get a lot on sunday or monday and i dont. Another great tweet comes from pelagic104, who writes, booyah, jim. Just finished your book you got screwed. Great book. Its just as relevant today as when you wrote it. I thought that book would be popular, a lot of people didnt like the title. I will say this. It was spoton about how wall street sometimes can really stab you right in the face, as well as the back. Mad money is back after the break. I like to say, theres always a bull market somewhere and i promise to try to find it just for you, right here on mad money. Im jim cramer. See you tomorrow doors, killing dreams and costing tens of thousands of jobs. Im here to fix this business. My name is marcus lemonis. In the past ten years, ive bought hundreds of failing businesses, turned them around, and ive made millions doing it. Ill write whatever check i need to, even if you wont. If you want people to listen, you put money on the table. Im gonna give you a check for 500,000. I found six struggling businesses, some weeks away from closure. My plan is to turn them around. For the next week, im 100 in charge. All right. Lets go get to work. Cant run a business if its not clean. But im not just giving them