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Friday,
January 16, 2009
(Cont'd from
above)...
Jim
(continued):
Now, I am going
to give you a
rule from the
second gospel
according to
Cramer… that is
Jim Cramer's Mad Money: Watch TV
and Get Rich,
the book… and
this rule is all
about preventing
loses… you won’t
get scared out
of the stock
market by
massive losses,
if you can avoid
them… right… it
stands to
reason… well one
of the best ways
to try to avoid
losses is to
follow my new
rule… and watch
out for multiple
contraction….
tricky, tricky
term… and we are
going to
explain.. if you
get a market
wide nose dive,
a big ugly
downturn…
especially when
it is driven by
global economic
slowdown that
causes growth
everywhere to
evaporate… you
need to follow
this rule.
What does it
mean… if you are
new to the game
a stocks
multiple is just
the share price
divided by the
earnings per
share… the
stocks multiple
is the share
price divided by
the earnings per
share… I repeat
it because you
hear all the
time on TV about
market
multiples, you
probably don’t
even know what
it is… I just
told you… okay…
in this if you
are in a jam and
can’t remember…
see the price to
earnings
multiple shows
you what the
market is
willing to pay
for a certain
level of
earnings… it is
called the PE
multiple… it is
how we can make
apples to apples
comparisons
between
different stocks
on different
evaluation, in
different
sectors, and in
same sectors…
typically the
market will pay
a higher
multiple for
earnings for
stocks that have
higher growth….
the market loves
growth… but
there will be
times when those
growth stocks
lose their
sizzle… when
sellers are
popping up left
and right… and
the stock is
suffering from a
bad case of what
is known as
multiple
contraction…
which means the
market will
start paying a
lot less for the
same amount of
earnings… boy
this thing is a
hidden disease…
a lot of people
get confused by
it… it only gets
worse if the
earnings
actually shrink
too… then you
have got a lower
multiple on
lower earnings…
that, that is a
disaster… that
is what hurts
people… remember
E X M = P
(price) and that
price will be
going down the
drain.
When a stock
catches a bad
case of multiple
contractions… it
will get cheaper
and cheaper… as
investors become
willing to pay
less and less…
for what may be
dubious future
earnings… only
certain types of
stocks are truly
vulnerable to
multiple
contractions….
high multiple
stocks… any
stock that
trades at more
than 30 times
forward earnings
estimates could
catch multiple
contractions…
any with a PE
over 40 is
almost begging
for it… those
are arbitrary..
some would say,
Jim, if the
growth rate is
so big can’t you
pay that… I am
just telling you
that that is
what happens…
that is the
history as I
have seen it… it
is too bad
because these
high multiple
stocks can be
some of the best
ones to own in a
good market… but
whenever the
market nose
dives… you need
to go thru your
portfolio and
identify your
high multiple
stocks… the ones
that you pay up
for the
earnings… and
see if they
might be at
risk… don’t
worry…usually
you have time
before they
symptoms of
multiple
contractions
start to set
in.. here is how
things usually
play out.
First, we will
see evidence of
a slow down… or
in better time
we will get a
rate hike… maybe
a rate hike too
far… and a lot
of stocks that
had been working
just shut down…
they plummet..
.but you don’t
see really
severe multiple
contraction
until your stock
report earnings…
so in other
words, stock can
get hit but it
really isn’t
just ghastly
until the
company reports…
so let me give
you an example
of what I mean..
it is called
back in the way
back machine…
let’s go to July
31st of 2006...
now we have
already had an
ugly for months…
nowhere near as
2008... but
every since May
of that year,
2006, when the
Fed decided …
incorrectly, of
course, to
destroy the
village in order
to save it… by
raising the
rates one time
too far… every
since then we
knew that we
were in big
trouble with a
lot of high
growth stocks…
even though
people have
become
pessimistic
about high
multiple stocks…
they had not
gone all the
way.. they were
not selling them
hand over fist…
and that was
your opportunity
to get out…
let’s give you
an example, on
July 31st Whole
Foods reported
its earnings…
there was a
speck of
negativity… same
store sales came
in at 9.9%
instead of the
estimated 10%…
Whole Foods was
a high flying,
high multiple
stock…you had to
do 11, 12, 13%
same store sales
in order to keep
it up there… so
immediately the
stock lost 10%…
it never
recovered…for
the next two
years though,
Whole Foods,
which had once
been a high
flying, high
growth name…
just went lower,
and lower, and
lower, and
lower… dropping
from the high
$50’s to single
digit… know we
have known about
the skittishness
of investors and
the weakness of
the market for
months… but it
took an adequate
earnings
report…just an
adequate one to
really cause the
multiple
contraction… you
had to see
that…you had to
recognize that
it was just a
little bit of
glitch… and then
predict what
would happen.
And we do that
all the time on
the show.
Your bottom
line...
▼ ▼
▼ ▼
▼
The Bottom Line!:
you want to avoid
taking serious
losses then be aware
of the disease of
multiple
contraction… when
you see a slow down
that the market
doesn’t like… then
you should probably
sell your high
multiple stocks
before they report…
unless you want a
world of pain.
If you want to avoid
taking losses, then
beware of multiple
contractions...
[verbatim recap]
[end of segment]
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