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Does a Price Break In a Stock Make It Worth Buying?

An important concept involving the process of investing, Jim Cramer said Thursday, is understanding if a price break in a stock makes it worth buying.

“What you have to do is to try to figure out if that sale the market's put on for a particular piece of merchandise is a buying opportunity or a precursor to still one more sale and then another sale,” the “Mad Money” host said. “Did the marketplace take the stock down too far and therefore you should be drawn to it? Or, is the big sale just beginning, so you're going to get smoked if you step in to do some buying?”

Too many investors make the mistake of not doing their homework when a stock posts a big decline, Cramer said. Investors need to read beyond the headlines to figure out why the stock got hammered, he said. Listening to earnings conference calls, reading the corresponding transcripts, watching interviews with company executives and evaluating economic data are all ways to research what might be impacting a stock.

To illustrate his point, Cramer pointed to railroad Norfolk Southern and retailer Bed Bath & Beyond, both of which declined by almost identical amounts Thursday.

Norfolk Southern’s stock fell after the company pre-announced disappointing numbers Wednesday, citing a major decline in coal shipments. Bed Bath & Beyond’s stock fell after the company said same-store sales fell sharply year-over-year while its gross margins also disappointed. Cramer noted that there are just “headline numbers,” though, and told investors to dig deeper.

“We try to figure out whether things are bad and getting worse, which means keep selling, or are things bad and can get better, which means you have to use the price break to do some buying,” Cramer said. “What's so compelling about this comparison, besides the almost identical price declines, is that both companies are extremely well run, with terrific balance sheets and fantastic reputations.”

So are things getting better or worse for these companies?

Cramer doesn’t think things look good for Norfolk Southern because government regulators are cracking down on coal, which means the railroads will have less to ship. At the same time, he said regulators have been friendlier to natural gas.

“That means we will most likely not see any new coal plants built in this country if President Obama is reelected, which means no secular growth to the rails that ship coal and no giant rebound in their stocks,” Cramer said. “To me, that suggests Norfolk Southern simply hasn't gone down enough yet, and the fact that it only yields 3 percent says ‘don't buy, don't buy.’”

Bed Bath & Beyond, on the other hand, paints a better picture in Cramer’s mind. While same-store sales have decelerated, he said the retailer’s margins were compressed because it’s integrating what would be an additive acquisition for next year. Also, Bed Bath & Beyond will likely be helped by the turn around in the U.S. housing market and benefits from a strong management team, he added.

(Related: Cramer’s Plays on the Housing Rebound.)

“To me that means the price break in Bed Bath, while perhaps not finished because there's no yield protection here can be bought and should not be sold,” Cramer said.

In the end, Cramer noted that “not all sales are equal.” Investors should do their homework to determine whether a major decline in a stock makes it worth buying.

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