Successful stock investing entails more than just a view of a company's prospects.You need a macroeconomic view and an understanding of how an industry sector is performing. In his book "Get Rich Carefully," CNBC's Mad Money host, Jim Cramer, gives readers advice on the metrics they should use to assess a stock to determine whether it has strong long-term prospects. Here's an excerpt.
1. First things first: Build a worldview of the macro forces at work around the globe so you can access the growth rates that determine so much of what ultimately makes a stock go higher.
2. Decide if you want a cyclical stock that needs worldwide growth, to "beat the numbers" or a growth-cyclical that needs less, or a discretionary play that's good for a slow growth environment or staples if there is little to no growth at all. Utilities, real estate investment trusts, and master limited partnerships can also work with no growth, but be careful of fixed-income equivalents. They might not be equivalent at all in a rising-rate environment and might mean more risk than you can handle.
3. Measure your company's growth rate against both the rate of growth in its own sector and the rate of world growth, if it is an international company, or domestic growth, if it is a company that sells only into the U.S. market. You need to make all of those comparisons if you want to identify less risky stocks that can give you a bigger reward in a difficult environment.
4. Get your top-down growth views from managements of companies on their conference calls. Caterpillar and Alcoa are best, but there are many others you must listen to if you are going to be informed about the global growth picture.
- Is there potential for multiyear growth?
- Is the total addressable market big enough to sustain growth?
- Can the company stay competitive against all comers?
- Will the company return capital to shareholders through dividends and buybacks, or are the growth opportunities too great and such capital returns would be a poor use of money?
- Can the company expand internationally?
- Can the balance sheet support strong growth?
- Is the stock expensive on the out years?
- Does the company have the right management to handle the growth?
- Does the company need macro growth to meet the numbers?
- Can the company maintain or grow its margins?
6. Understand which hidden metrics really matter in each sector, as they won't necessarily be the earnings per share. Know the best of breed of each sector if you want to invest in it and don't you dare trade down; it's just too risky.
Text copyright © 2013 by J.J. Cramer & Co. From JIM CRAMER'S GET RICH CAREFULLY, reprinted with permission from Blue Rider Press, a member of Penguin Group (USA) LLC.