Sometimes you’ll get behind a small, relatively-unknown stock that gains a bunch of momentum. You won’t want to bail, but eventually you will have to. Owning small stocks that are on a tear is a good way to make money, but you need to know when to sell because, sooner or later, all hot stocks will implode.
You need to figure out when the interest in the stock has peaked, and the best way to do that is to check the analyst coverage, Cramer says. A good rule of thumb is that once a hot stock has four analysts covering it, the run is probably coming to an end.
Analyst coverage is a pretty accurate indicator of how much general awareness and interest there is in a particular stock. Hot stocks get tapped out when there’s no one left to be attracted to them; when all the people who are going to buy have already bought. And by the time that happens, you need to be out.
A great recent example of this is Hansen Natural , Cramer says. Hansen gained momentum in 2004 and rode the momentum all the way to mid-2006. Adjusted for the split, HANS went from around $18 in the beginning of 2005 to $200 when it topped in July 2006. The whole way up, people were calling on Hansen to crash and burn because it was getting all its momentum from its Monster Energy Drink. It did indeed burn out, but it took years to do so. And one of the reasons it cooled off when it did, Cramer says, is because it reached the critical mass of analyst coverage in May 2006, just two months before the slide began.
Bottom Line: You can definitely own small, hot stocks, but you need to know when to sell. Once you see too many analysts jumping on the bandwagon, it’s probably time for you to jump off.
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