GO
Loading...

What Makes a Stock Cheap?

Cramer on Monday said that over the last 24 hours, there has been a lot of talk about how stocks are cheap.

But whether a stock is cheap depends upon who you ask, the "Mad Money" host said. When it comes to determining whether a stock is cheap, we only care about the opinion of a few groups of people. Hedge funds and mutual funds are one of those groups, Cramer said. They are playing what's known as earnings momentum. These growth stock buyers are trying to figure out which companies can beat the earnings estimates set by Wall Street. It matters what these buyers think because they buy massive amounts of shares, giving them the ability to move the stock immensely.

Companies making acquisitions is the only other group, whose definition of cheapness we care about, Cramer said. This group is looking to buy other businesses in order to boost their earnings.

"If you're thinking about buying a stock that doesn't fit into their parameters, then think again," Cramer said. "No matter how inexpensive a stock might appear to be, it won't go higher unless it can attract hedge fund and mutual fund buyers or a takeover bid."

Technology and bank stocks are said to be cheap right now, but Cramer thinks they're value traps. While these stocks look cheap on paper, he thinks they lack growth and have no prospects for a dividend boost any time soon.

To money managers and companies making acquisitions, the cheap stocks are those with the strongest earnings momentum. Companies, like Netflix , Amazon.com , Caterpillar and Cummins , for example, are considered cheap because they have earnings that could be huge versus future estimates. In other words, if these companies continue to deliver, they'll prove to be very cheap in a few years time. By looking for high-growth companies, home gamers can anticipate what hedge funds might buy.

The other area to look at is takeover targets, Cramer said. These are companies that get bought because their stocks are too cheap versus what some other company can buy and make work. Trying to discern what might appear to an acquirer is difficult, Cramer said. He thinks it's worth trying to identify takeover targets, but without a catalyst of a deal, these stocks are not likely to move up on their own.

So what's the bottom line?

"What you think is cheap, what the journalists or analysts say is cheap, really doesn't matter," Cramer said. "Cheapness is in the eye of the managers who put money to work every day. The marginal buyers. You have to think like them if you want to find stocks that are going higher."

When this story was published, Cramer's charitable trust owned Caterpillar and Cummins.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

Questions, comments, suggestions for the Mad Money website? madcap@cnbc.com

Symbol
Price
 
Change
%Change
AMZN
---
CAT
---
CMI
---
NFLX
---

Featured

Contact Mad Money

  • Showtimes

    U.S.
    Monday - Friday 6p ET
    Australia
    Saturday 8a, 1p, 7p SYD
    Sunday 12a, 1a, 8a, 7p SYD
    New Zealand
    Saturday 10a, 3p, 9p NZ
    Sunday 2a, 3a, 10a, 9p NZ
  • Jim Cramer is host of CNBC's "Mad Money" and co-anchor of the 9 a.m. ET hour of CNBC's "Squawk on the Street."

Mad Money Features

  • Grab the latest CNBC gear from the NBCUniversal Store!

  • Get a behind-the-scenes look at how Cramer formulates his investment advice. "Inside the Madness" is a column, which features e-mails and more with Cramer and his researcher Nicole Urken.

  • You’ve always wanted to hit the “Hallelujah!” button. Here’s your chance.