- "Mad Money" host Jim Cramer explains why homework is not always the determining factor in investing.
- In the cases of Amazon, Netflix and Tesla, Cramer says traditional homework would have prevented investments in these successful stocks.
- All in all, Cramer argues that good investing nowadays should consider the strength of the company's product as much as, if not more than, the fundamentals.
When Jim Cramer was new to the stock business, he read legendary fund manager Peter Lynch's 1989 book, "One Up On Wall Street: How to Use What You Already Know to Make Money in the Market."
The book revolved around a key piece of advice: if investors kept their eyes open to products or experiences they liked, they would have an easier time finding profitable investments.
Lynch wrote that enjoying companies' offerings should lead investors to research those companies and make informed decisions about whether to buy their stocks.
"But a funny thing happened since Lynch penned his seminal work," the "Mad Money" host said. "The homework has, in some cases, actually kept you out of stocks that you might otherwise have owned and made fortunes in."
Amazon, for one, was considered to be overvalued for years. The e-commerce giant made little to no money, relying on financial markets for funds because investors believed in the company.
Cramer argued that Netflix's rise was no different. If investors had done their homework on the streaming service, they would have seen that it was a money-losing machine.
"Making things even more difficult, on the recent conference call, CEO Reed Hastings actually championed the notion that negative free cash flow, something I don't like, 'will be an indicator of enormous success,'" Cramer said. "I just don't think that would pass the Lynch test."
Given that Netflix expects to see between $2 billion and $2.5 billion in negative free cash flow, or capital spending that costs more than the company's operating cash flow, this year, the company seems to be on the right track, at least according to Hastings.
Perhaps the most pointed exception to Lynch's investing rule is Tesla. On Monday, the automaker announced plans to raise $1.5 billion in a U.S. bond offering to fund its growth.
The offering comes as Tesla scales up production of its Model 3 sedan, a product already in high demand and beloved by consumers. Cramer said that aces the first part of the "Lynch test."
"But the second part? Whoa! It's almost impossible to tell how much money Tesla makes per car, if anything. Nor is it possible to define the future of the company," Cramer said. "If everything goes right it could be the next Amazon, a tech company that sells cars, just as Amazon's a tech company that's in retail. If it doesn't, then the stock could flame out."
All in all, homework is valuable, but it can sometimes keep investors from chasing some of the market's most lucrative stocks, a mistake Cramer has made himself, he admitted.
"I wish I had an answer for this conundrum. Maybe you just take some real 'Mad Money' and buy one of them: preferably Netflix or Amazon because they're far more proven than Tesla," Cramer said. "No matter. The fact is that some stories flunk the near-term fundamentals even as they triumph over the long term. ... Two of these three have already done so. For all I can tell, the third will, too."