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Cramer: 6 key stock sectors to watch

Monday, 3 Feb 2014 | 8:04 AM ET
Retirement fund: Stocks vs. bonds
Thursday, 30 Jan 2014 | 6:45 PM ET
"Mad Money" host Jim Cramer explains why he doesn't suggest owning bonds in your retirement fund until age 30. To get the most out of your IRA or 401(k)s, Cramer says to take some risks by investing in stocks more than bonds.

In his new book, "Get Rich Carefully," CNBC's Mad Money host, Jim Cramer, gives readers advice on how to evaluate growth stocks with strong fundamentals. As he explains, investors should assess market dynamics to find sectors with long-term potential. After that, it's time to use key hidden metrics to benchmark potential stock picks against others within the industry group.

We've listed just six key sectors here, but in his new book, Cramer provides a complete overview of 40 industrial, tech and service sectors.

In every case when I am judging a sector, I find myself trying to assess how a company is doing versus others in its group on what we would consider an apples-to-apples basis. After many years as a generalist scrambling to figure out what the analysts really care about, I have put together this cheat sheet so you can quickly determine how your stock stacks up on the issue that matters for its industry. In each case, in light of that hidden metric, I will give you the best of breed in the sector it dominates.

AUTOS: We measure autos on their percentage of the seasonally adjusted annual rate of cars sold. While U.S. sales matter, almost all auto companies are now global, so we care about units sold in both Europe and China, the former currently overshadowing the domestic market and the latter soon to eclipse the domestic market in terms of importance. Here Ford is the best-of-breed auto company, and Magna is the best-of-breed auto-parts concern.

HOUSING: Housing companies are graded on their backlog numbers, sales and how much they make per home. If a company can't close as many deals as expected, or if a lot of its deals are canceled, the stock will likely be downgraded even if it has legitimate reasons for the shortfall. Toll is the finest, but I like to play housing in ancillary ways, typically through the tremendous housing-related retailers like Lowe's and Home Depot.

MEDIA: Advertising dollars and subscription dollars both matter now that many media entities charge for access to the web. Before the sub model changed, we cared about circulation, but that has diminished in importance now that sub fees have made up an increasing amount of revenues. I like what Gannett has done to augment both streams. Time Warner has done a fabulous job too. The Publicis-Omnicom combination will produce the best-of-breed player in advertising.

(Read more: The metrics Jim Cramer uses to find value stocks)

OIL SERVICE: Monitor these through the Baker Hughes rig count. While these are international companies, they all mistakenly trade on how much drilling is going on in the United States. The rig count, released once a week, gives you the story, even though it shouldn't be the key metric. Sometimes you just have to let things go and say, "Even though this number shouldn't count that much, it does," and move on. Fortunately, one company, Schlumberger, rises above all others and is the must-own in the group.

SOFTWARE: It's very difficult to compare apples to apples in the software business, but I like to look at the unearned revenues as a guide to future earnings. Advanced payments—or unearned revenues—are recorded as a liability until services are rendered, so they aren't obvious but they are disclosed. These are usually sizable because they represent licensing fees and annual maintenance charges that must be prorated. They give you the best indicator of what's to come. Salesforce.com takes the crown here.

TECH: It may sound quaint at this point, but we can still measure the health of a tech concern, like a semiconductor or a disk drive company, by its book-to-bill ratio, whether it is receiving more orders than it can ship. If it is, then it is possible that the average selling price can go higher, which would expand margins and increase earnings that would allow companies to beat and raise estimates. I follow the construction of new factories that would add to capacity and therefore trigger an oversupply of product. I also monitor yields, meaning how much product companies like Intel have to throw out because of imperfections before the assembly line starts to hum. You always have to be careful of new assembly lines because of poor yields; sometimes the manufacturers have to throw out about half the product at the start of a new run. Each quarter it gets better, but the bad yields have a huge impact on gross margins, which are critical to the bottom line. Tough one, but I still have to go with Google, as it is the best run and most creative in the sector.

Jim Cramer's new book, "Get Rich Carefully"
Adam Jeffery | CNBC
Jim Cramer's new book, "Get Rich Carefully"

—CNBC's Jim Cramer. Follow him on Twitter @jimcramer.

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.

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