Inside the Madness

Cramer: Remember the Limits of Your Toolbox

From: Nicole Urken
Sent: Friday, November 11, 2011 11:54 AM
To: Edward Graham; James Cramer
Subject: RE: GMCR

Btw – reading thru the conf call (attached) more closely... Was very surprised that analysts didn’t address patent issue / Einhorn concerns more thoroughly

From: James Cramer
Sent: Friday, November 11, 2011 12:30 PM
To: Nicole Urken
Subject: RE: GMCR

The analysts are missing the mark on this one

The above email exchange is key for a couple of reasons.

One, we often cite Wall Street research on "Mad Money," noting relevant facts that are presented by different brokerage firms as key data points that help guide our investment conclusions. In addition, sometimes an upgrade or a downgrade by a brokerage firm shifts our view of a stock we had previously been bullish or bearish on. On Wednesday, for example, Jim discussed how Goldman’s upgrade on Research in Motion based on a sum-of-the-parts analysis made him more bullish on the stock, particularly because the firm had ridden the stock down over 70 percent with its previous appropriate 'sell' rating that many others missed.

HOWEVER, it is key to note that using research from Wall Street brokers needs to be used only as a jumping off point for forming your investment decisions. It is just ONE tool in the toolbox—and relying on any particular source or strategy just doesn’t cut it when it comes to making a sound investment decision. After all, there are often big discrepancies between the views of different firms—so of course going with the view of one particular analyst isn’t prudent. In fact, on "Mad Money," we have presented “Wall Street brawls” when research analysts have, well, exactly opposite views about a stock.

Worse, though, there is a tendency among the sell-side community to fall into “group think” where there is overdone adulation of a stock (or, conversely, overdone negativity). Case in point: Green Mountain Coffee, a stock that seems to be in the news nearly every day. While off its lows, this name has been cut in half since mid-September from over $100 a share to a bit over $50 a share on concerns that renowned hedge fund manager David Einhorn raised about their K-Cup patent along with recent slowing consumption trends. In the company’s most recent conference call, the analysts did not even bring up a question about the patent, nor was it acknowledged in the widely positive research notes, defending the stock without a mention of the loss of 50 points.

You as an investor, though, cannot ignore those 50 points. The company’s lack of acknowledgement to consider increasing competition upon a patent fall-off (and research analysts choosing to ignore this fact) frankly means that their growth forecasts are off base.  You, as an investor, must acknowledge these risks and issues, even if research analysts ignore them. Perhaps if the Green Mountain analysts were attuned to the red flags that healthcare analysts pay attention to, they would have been more wary of patent issues.  These are highlighted all the time at Eli Lilly, Bristol Myers and others in the pharmaceutical cohort. Instead, the GMCR consumer analysts have focused only on consumer variables, missing a huge piece of downward pressure on the stock.

In other words, Wall Street research can often be extremely informative, but it needs to be just one tool in your toolbox. The importance of not relying on any one resource or tool is true of all the methods we talk about on "Mad Money."

What other tools should not be used in isolation? Every Tuesday, we run “Off the Charts” highlighting technical indicators for indices, exchange-traded funds or individual names.  However, as we always emphasize, chart analysis is a helpful “check point” on your fundamental thesis and a helpful guide, but should never be relied upon in isolation. For example, one key point many technical analysts often focus on is a stock falling below its 200-day or 50-day moving average. But, on a fundamental basis, a high quality stock getting cheaper could make for an interesting entry point, something we’ve talked about with names that present long-term opportunities like the domestic shale plays like Continental Resources and EOG Resources.

What else? All week, we have been comparing the PEG ratios of companies (looking at their price-to-earnings multiple relative to their long-term growth rate) to assess how expensive they are as stocks. Again, while this is a helpful screening exercise, it doesn’t always work. Why? Because long-term earnings estimates (which are factored into the analysis) may be over-stated or may not capture the full market growth opportunity. And just because a company has a reasonable PEG rate doesn’t mean it’s a “buy”—as there can be many industry risks and broader factors placing downward pressure on the stock—something we have discussed for example with First Solar.

In Thursday's Dunkin Brands vs. Starbucks segment, we did highlight that when you consider the growth rate, Dunkin loses its appeal as a cheaper stock on a P/E basis (i.e. it becomes marginally more expensive than SBUX on a PEG basis). But in reviewing our analysis after the segment aired, we discussed that even though Dunkin is marginally more expensive than Starbucks on a PEG basis, this small ratio differential doesn’t effectively capture the quality differential of the two names. In other words, there is more to stock analysis than simply looking at valuation—and the quality of Starbucks’ management and execution far outweighs the newbie status of Dunkin as a public name.

The bottom line: Always remember that each strategy we present on "Mad Money" and the resources we use should be seen as tools that fit into a larger toolbox. You never want to rely just on a screwdriver without a hammer or a tape measure. All are important in forming an investment opinion. Don’t fall into the trap of relying on just one metric or one source—because in the end, you’ll be the one with 50 less Green Mountain points… and the screw driver alone will have, well, screwed you. Don’t forget the hammer and the tape measure too.

"Inside the Madness" appears twice a week at

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