Mad Money

Cramer’s false floors: Careful investors, don’t slip

Sometimes buybacks can't save a stock: Cramer

(Click for video linked to a searchable transcript of this Mad Money segment)

Jim Cramer often advocates viewing a sell-off as opportunity. However, you can get badly burned if you buy too soon.

It's a lesson Cramer learned the hard way.

"After reviewing every trade made by my charitable trust over the past year I found that sometimes when I saw a stock that was spiraling lower, I moved too soon and bought before the pain had come to an end."

Cramer wants you to learn from his errors.

"I found I made seven mistakes time and again. I've come to call them false floors, because they were deceptive, kind of like a trap door that you fall right through."

"Right here, I'm going to warn you about two of the worst ones. You can read about the rest in my soon to be released book " Get Rich Carefully."

Mark Hooper | Uppercut Images | Getty Images

False Floor # 1: A big buy back

A corporate buy back puts a sizable buyer into the market. And it stands to reason that a big buyer should generate support when a stock would otherwise sell-off. Afterall, a buyback should shrink outstanding sharecount.

However, in this circumstance, Cramer says fundamentals really come into play. That is, if a stock is selling off simply due to a bad quarter or an isolated catalyst, then a buy back could help stabilize shares.

But in the event the company isn't producing good numbers or if there's a sector wide downturn, Cramer says the buyback won't matter.

That is, it simply won't introduce enough buying to offset the waves of selling.

"So if you own a stock that's getting hammered, or you're thinking of buying one, and you expect that stock to be saved by a huge , be warned: that buyback will not save you. It's a false floor," Cramer said.

False Floor #2. No stock is too cheap to sell

When shares tumble fast and hard, often times pros will wonder if a stock was oversold. And in the near-term it may be. But there's probably a good reason behind the decline, as well.

"Let me give you an example of this kind of erroneous thinking. Back in February of 2010, the charitable trust was drawn to Teva Pharmaceutical, the big maker of generic drugs with a major proprietary drug kicker in the form of , its blockbuster multiple sclerosis medication. At the time the stock had fallen hard, trading down to $58, where it was selling for just twelve times earnings—very cheap versus its historical average multiple of eighteen times earnings."

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"But Teva just kept on dropping, and by the time it traded down to the mid $40s, becoming cheaper still at just ten times earnings, I learned that one of Teva's competitors had been able to come up with a generic challenge to Copaxone, their huge blockbuster drug franchise, something Teva's management had repeatedly assured us could not happen. Well, it did happen, and while the generic wasn't going to be able to launch for a few more years, I realized that as soon as this generic hit the market, say in 2015, it would to tear Teva's earnings to shreds."

"The truth is, cheap stocks are usually cheap for a reason, and when stocks hit new lows, it's usually because they deserve to be hitting new lows."

Call Cramer: 1-800-743-CNBC

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