Investor conundrum: Cyclical or secular?

(The video above was first made available on Aug., 30, 2013. Click to go to a searchable transcript of this "Mad Money" segment)

Before you put your next dollar in stocks, Jim Cramer would like a word about cyclical versus secular.

The "Mad Money" host is concerned that far too many individual investors don't really understand the differences and therefore risk losses, needlessly. And he doesn't want you to be among them.

Cyclical stocks

"We say a company is cyclical if it needs a strong economy in order to grow; it's cyclical because it depends on the business cycle," Cramer explained. "Steel producers such as US Steel, or Nucor fall into this category, as do machinery companies like Caterpillar or Ingersoll-Rand, along with raw materials plays like BHP Billiton, and chemical companies like a Dow Chemical or a PPG, the old Pittsburgh Plate and Glass."

If you put money to work in cyclical stocks essentially Cramer says you're betting on improvements in the global recovery.

Taken one step further, when Wall Street largely agrees that the global economy is robust, these companies command a greater premium than when the health of the globe is called into question. Therefore, the key to profiting from these stocks is watching economic signs and buying strategically, right before significant signs of improvement.

However, "You don't want to own much in the way of cyclicals when you see the economy's slowing. When that happens they get crushed. That is, they command a much smaller premium because investors fear their earnings could fall apart."

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Secular stocks

Conversely, "A secular growth company is one where the earnings trajectory remains relatively constant despite the state of the economy," Cramer explained. "Typically secular growth refers to consumer staples companies such as Procter & Gamble or Colgate, food makers such as General Mills or Kellogg, tobacco companies including Altria and drug stocks such as Pfizer or Merck.

Sometimes called defensive stocks, when you put money into cyclicals, you're betting that the economy will either slow or not grow as rapidly. Therefore, it's most strategic to buy these stocks right before signs emerge suggesting the economy has peaked.

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As an individual investor, Cramer thinks it's critically important to understand these two fundamental ideas about stocks, and then use the information to manage money actively.

Don't forget, Cramer believes every stock comes with an expiration date and he often says don't buy without first developing a strategy for selling.

Closely watching the balance between cyclical and secular stocks in the market should not only inform your sell thesis, Cramer says it can help you maneuver, and therefore avoid some serious pain as fundamentals begin to shift.

*Editor's Note: This "Mad Money" segment first aired on Friday August 30, 2013 and the video above is from that time.

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