Mad Money

Cramer finds a new way to look at 'broken stocks' in a sell-off

Key Points
  • "Mad Money" host Jim Cramer clarifies the difference between broken stocks and broken companies.
  • When pullbacks happen, investors get a chance to pick up battered stocks of good companies at a bargain, he says.
  • But the telltale signs of broken companies are to be avoided at all costs, Cramer says.
How to look at 'broken stocks' in a sell-off
How to look at 'broken stocks' in a sell-off

Jim Cramer's motto in a downturn is to buy broken stocks, not broken companies.

When the market undertakes huge losses, investors have an opportunity to buy good companies with stocks that have taken an unfair beating because of the market, the "Mad Money" host said.

There's a huge difference between a broken company and a broken stock, and being able to thrive in a sell-off requires knowing the difference.

That's why Cramer said the first thing to do amid a market-wide sell-off is look at the companies that caused it.

"If you're looking at a company that is part of the reason for a correction, you're looking at a broken company. Those are directly in the blast zone and certain to be obliterated," Cramer said.

For instance, in 2007, there were multiple sell-offs related to a weak real estate market, and tons of bad subprime and regular loans. Any entity that touched housing, mortgages or any kind of lending would have been considered a broken company.

Cramer also reminded investors that a company does not break just because its stock goes lower. Investors saw this in 2012 when domestic companies were brought down just because of turmoil in Europe.

How could a fast-casual Mexican chain like Chipotle take a hit because of Italian bonds? "Well, it happened," the "Mad Money" host said.

Stocks like Chipotle went down because all stocks were going down at the time, not because it had a connection to the sell-off.

"To put it another way, you don't want to buy the stocks that are leading the decline when you're looking for opportunity in a sell-off. You want to look for stocks in areas that are independent of what's ailing the market," Cramer said.

Once a company breaks, it is very difficult to put it back together again. The same goes for sectors, which control half of their stocks' movements.

In a sell-off, some stocks will have a clear reason for going lower, and others will just be sold off with everything else. The first stocks to be sold will be the broken companies — which Cramer says to avoid at all costs — and the second group will be the broken stocks. Those are the stocks to gobble up quickly if you want to take advantage of a correction, Cramer said.

WATCH: Cramer's case for 'broken stocks'

Cramer finds a new way to look at 'broken stocks' in a sell-off
Cramer finds a new way to look at 'broken stocks' in a sell-off

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