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When Not to Sell a High-Growth Name

Thursday, 14 Apr 2011 | 9:27 PM ET
Short-Changed?
How can you tell when it's time to abandon a high-flyer? Money managers love to bet against growth stocks whenever an analyst downgrades them to a sell. Never buy a stock because it looks cheap. And don't bet against something just because it looks too rich, says Cramer.

"How do you tell when a high-flying, turbo-charged growth stock has become too expensive?" Cramer asked Thursday. "How do you know when it’s time to abandon a fast-grower with lots of momentum? When it’s time to sell something because it’s gotten too pricey?"

Cramer doesn't have the answers to those questions, but he does know one thing: it's not when an analyst downgrades a stock to a "sell."

In the last two years, sell calls based on valuation have lost fund mangers money, Cramer said. While hedge funds must keep some short positions on the books, money managers have lost fortunes trying to short high quality growth stocks because they seemed too expensive. Cramer said investors should never bet against something just because the valuation is too rich. After all, companies that are executing well can continue to go much higher regardless of high overpriced they seem to be.

Take Perrigo , for example. The Allegan, Mich.-based company makes private label, store brand over-the-counter drugs and enjoys a 70 percent market share. Its stock has posted an 88 percent gain since Cramer first got behind it on February 9, 2010 when it was trading at $46.42. At the time, Cramer liked Perrigo as a trade-down play on a more value-conscious customer. Many analysts had long rated the stocks a "sell," but on Wednesday, a Goldman Sachs analyst upgraded it to a "hold." The next day, an analyst from Buckingham followed suit, upgrading the stock from "neutral" to "buy."

Citing valuation, Goldman had a "sell" rating on Perrigo since July 19, 2010. Goldman told investors to sell the stock down to $50, but the stock ran up from $57.34 to $87.53, Cramer noted. Those who listened to Goldman would have lost out on a 53 percent rally, he said. Now that Goldman has upgraded the stock, Cramer recommends investors sell half of their position in PRGO.

"Lock in the gain after news like this because this Goldman upgrade is the exact same thing as some analyst who capitulates and downgrades a loser-stock all the way down," Cramer explained. "When the people who hated a stock all the way up start to capitulate, you have to get more cautious because it could mean there’s less upside going forward."

Those in doubt should look to what recently happened with Netflix , Cramer said. Many analysts recommended shorting this name all the way up, but then the critics started to capitulate. Noted short-seller Whitney Tilson ot T2 Partners had been outspoken in his criticsm of the stock, but then had to cover his short position in February. As a result, the stock soon soared to new highs, but then spent the next few weeks falling more than 50 points.

"When the critics threw in the towel, you had to take some of your position off the table," Cramer said. "Apply that lesson now and ring the register on some Perrigo in honor of Goldman's capitulation."

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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