Best way to make big bucks on activists

Cramer talks new face of activist investing

Jim Cramer has noticed that activism has become the hot trend on Wall Street lately, as a way for activists to strong arm management into doing things their way. This new breed of activist funds currently manages roughly $120 billion in assets, up 30 percent in the past year.

But does it really work?

The Wall Street Journal published an article by Yale School of Management professor Jeff Sonnenfeld last week with a scathing review of activist hedge funds and their poor performance. Sonnenfeld pointed out that investors don't necessarily make a lot of money by following activists or their funds.

Cramer agrees with this perspective, though he considers Nelson Peltz to be the exception to the rule. So, how could these supposedly genius activist investors give you poor returns?

Pedestrians walk passed The Children's Place retail toy store in downtown Boston.
Jared Leeds | AP Photo

There is certainly a big return for the hedge funds that are playing the activist game. Once they have the label as an "activist" it is much easier to raise money, and hedge funds are all about raising money.

"Next time you think of activists, I don't want your mind to go to a deep-pocketed, old school corporate raider like Carl Icahn or a turnaround specialist like Nelson Peltz," Cramer added.

The fact of the matter is that most activists are small-time, like Macellum Advisors' 2 percent stake in The Children's Place. It is urging the company to make various changes in order to create value, which caused the stock to jump 8.6 percent in one session.

Why did they choose Children's Place? Simply because it has a long history of underperformance since the new CEO, Jane Elfers, took over in 2010. Macellum's actions came straight from the textbook.

Macellum pointed out that Elfers has repeatedly talked about optimizing inventory management, and in the past five years there has not been an improvement. Additionally, Macellum believes that Children's Place tried to expand too quickly after the Elfters took over, and it retracted in 2012.

"In short, when you're one of these smaller activist funds, you go after companies with a track record of poor performance and inept leadership," Cramer added.

But those are not the stocks that investors should be buying! Cramer has always only recommended the best of breed companies.

And while the overall goal of an activist is to create change that helps to generate more value, the "Mad Money" host pointed out that often the activists are only interested in creating short-term value to boost their own returns.

Ideally, Macellum would like Children's Place to put itself up for sale, but then it also claimed that if the company were under the right leadership it could double its earnings per share. No wonder the stock has skyrocketed!

Cramer takes activists like Macellum with a grain of salt. After all, it only owns 2 percent of the company. There's really not a lot they can do to enforce these demands.

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"You should never invest in a company just because a so-called activist has gotten involved," Cramer said.

Instead, Cramer thinks it makes more sense to sell into the spike of an activists rather than buying it.

Ultimately, activists like to target poorly run companies that perform terribly, not the well-run companies Cramer recommends to Cramerica. Remember, activists could sell their stock without investors knowing, and you could be left holding the bag.

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