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A Lesson In Becoming a Better Investor

Thursday, 23 Jun 2011 | 7:29 PM ET

"I’m always trying to teach how to become a better investor," Cramer said Thursday. "On a lousy day like this one, it’s important to understand what makes stocks worth owning."

When picking stocks, the "Mad Money" host said investors need to be able to accurately judge the potential upside. Investors can't just take an analyst's price target as gospel, though. They need to know what goes into making those targets, he said.

Cramer's Mad Money Sell Block
Mad Money's Jim Cramer tells you which stocks you ought to be selling right now, either to take profits or to cut your losses.

To further explain, Cramer pointed to Cabot Oil & Gas . Having posted a 60 percent gain year-to-date, Cramer said it is the best performing exploration and production stock right now. The rest of the exploration and production stocks are up by just 5 percent while the S&P 500 is up less than 1 percent.

The analysts have price targets all over the map on COG, though. Howard Weill put it at $47 while Jefferies and JPMorgan both have $62.50 as their target. Goldman thinks it’s worth $72. Canaccord raised its price target to $85 and Bank of America has a sky-high projection of $105.

So what's COG really worth?

Cramer thinks Cabot was too cheap earlier this year. The market wasn't getting it enough credit for its acreage in Pennsylvania's Susquehanna County, a resource rich area of the Marcellus shale. After the stock's big run, however, Cramer thinks the sky-high target from Bank of America doesn't discount what could go wrong for the company.

Cabot soared thanks to strong production results and a bullish reserve growth outlook, Cramer noted. At roughly $60 a share, he thinks the potential upside isn't much greater than the potential downside. For that reason, he's putting COG on the "Sell Block."

So if the stock makes sense at around $60, where did Bank of America get that $105 price target? Cramer thinks it has to do with net asset value, which he considers a dangerous concept. When an analyst gets bullish on a stock, he explained, they have to find a way to justify their price target. Since Cabot hasn't come out with its own net asset value figures, Cramer said these numbers are entirely in the eye of the beholder.

When it comes to exploration and production companies, the net asset value is based on assumptions about the future, such as the price of natural gas, whether pipeline infrastructure will be there to transport the gas and how much new oil and gas the company may find. When Bank of America made its assumptions, it wasn't very careful. It figured Cabot's net asset value was $129 a share, so they discounted that figure by 20 percent to come up with their $105 price target.

The 20 percent discount isn't enough, though, Cramer said. Chesapeake Energy , a higher quality company by Cramer's standards, trades at just 50 percent of its assessed net asset value. He thinks that's more realistic than the numbers Bank of America made for Cabot.

After Bank of America set its price target, other analysts followed suit. Cramer said the optimism got out of hand. He thinks its number is too high because it doesn't take into account infrastructure complaints and limitations on Cabot's business, like a lack of pipeline infrastructure and the cost of building it out.

The bottom line is that you always have to take net asset value targets with a grain of salt, Cramer said. For those that own Cabot, he suggests taking a little off the table.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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