×

Cramer Remix: Detecting a best-of-breed company

Every night, Jim Cramer goes on "Mad Money" with the mission to help people become better investors. In the past 10 years of the show, the evolution of that mission has transformed to match the surrounding environment.

The show first began as an outgrowth of Cramer's radio show called "Real Money." At that time, people were craving specific investment ideas. Everything changed when investors were hit with the Great Recession, which shifted the way investors viewed the market.

During that time, there were many big companies that were destroyed by the downturn, especially financial companies, along with the dramatic decline in economic activity.

"That era changed things, and it changed me. It changed the show," the "Mad Money" host said.

Ultimately, Cramer believes that stocks can be one of the greatest investment vehicles out there. They represent the sum progress of a business and the prospects for that business going forward. They can also share that wealth with shareholders and be very rewarding.

Cramer wants investors to come along for the ride with stocks, but that means doing it in a responsible way. That is why he always suggests an index fund as a safe way to invest.

"The show has changed over time from one where we pick stocks for you, to one where we educate you about stocks so you can understand why an index fund might be worth investing in," Cramer said.

Read More Cramer: Hot stock picks just don't cut it anymore

Do your homework
Kanawa_Studio | Getty Images

So, why even bother owning individual stocks?

"I think this show can play a role in your financial education and get you to the point where you make fewer errors and have more of a chance to make money longer term if you choose to invest in individual stocks as well as index funds," the "Mad Money" host said.

That is why he created the following four rules for owning stocks:

No. 1 Tips are for waiters.
No. 2 You must do the homework if you are going to own an individual stock.
No. 3 If you can't do the homework, then own an index fund.
No. 4 If you fear losing money, don't own stocks at all because they will go down as well as up.

Read More Cramer: Want to own stocks? My top 4 rules

When Cramer was in law school, he saw the beginning of the indexing of individual stocks. He saw the bundling first of the stocks followed by the Value Line Company, an influential firm at the time, and then ultimately the S&P 500. However, Cramer was more interested in individual stocks.

In 1984, when Cramer started at Goldman Sachs, he used to get a call from his mother, who loved the stock market and would call for quotes on her favorite stocks. And with all of the fancy research available at that time, she chose to invest by buying what she knew and staying on top of it.

She liked to shop at Giant Food, a progressive supermarket chain at the time, so she bought the stock. The process of homework back then was to like an idea through personal experience, read up on it with the best research and match those insights with other firms. Cramer also learned during that time that sometimes Wall Street research can be very wrong, so a healthy dose of skepticism is a good thing.

"I want to show you that it isn't reckless to try to pick individual stocks and those who say it is just don't understand the process of first-hand experience, married with research and buttressed by skepticism. It all increases the odds of successful individual stock investing while minimizing the risks of single stock ownership," Cramer said.

Adam Gault | OJO images | Getty Images

When Cramer first graduated college, he worked as a reporter covering sports and government in Tallahassee, Florida, where he made $153 a week. And while he didn't have a lot of money to spare, he did find a way to save in his IRA and began to buy individual stocks for a personal account.

"I was going to do it the right way, by researching stocks and getting an edge through that research," Cramer said.

After losing money on a few investments, Cramer decided to go to the library and research companies. Eventually, he found a company called Natomas, which had just discovered a large find in Indonesia. He took $300 and bought the stock, and it quickly caught a takeover bid.

Cramer realized from his investment in Natomas that by doing the homework, it gave him an edge over others and helped to arm him with the proper knowledge about a stock. He was hooked on stocks and never turned back. Eventually, Cramer made enough money to pay for his first year of law school when he decided to become an attorney.

Read More Cramer: My method to getting an edge on a stock

And when Cramer decided to leave Goldman Sachs after four years and open his own hedge fund, the first stock that he bought was Heinz. Why? Because he liked to own a stock that represented a call on great management that could deliver earnings through thick and thin.

What he didn't count on were the performance demands of a hedge fund manager. He quickly learned that just buying a stock because it was terrific didn't matter to the fund, and those long-term investments did not produce daily performance.

"Heinz was a staple with a good dividend and what I didn't understand at the time was when the economy heats up people dump these kinds of stocks for something more cyclical," Cramer said.

Cramer didn't get that if he wanted to perform daily, he would have to take daily action. You can't just sit there and take a beating because you own best-of-breed companies.

But here was the problem—this rotation game is not one that investors can play at home without being a full-time professional. And eventually when the market got too hot, it crashed and all of the cyclical plays were decimated.

But guess what? Heinz snapped right back. That is what happens to best-of-breed well-managed companies.

"As a home gamer, you can use the flailings of the hedge-fund performers to your own advantage by picking up best-of-breed companies," Cramer said.