Speculation for Dummies

Cramer told a story Friday about some loudmouth touting his buy of Washington Mutual at $3 a share. Apparently this guy thought WaMu was ripe for a takeover.

Too bad he never reviewed this failed bank’s balance sheet. If he had, he would have noticed the massive debt on WaMu’s books. Plus, this would-be speculator actually thought all the bank’s credit downgrades were a good thing, instead of realizing, as Cramer did, that such downgrades usually sound the death knell for most financial institutions.

Any potential buyers of WaMu would be taking that along with any deposits the bank had. And the debt holders – bond bullies, as Cramer likes to call them, would get their money long before any holders of common stock. And what if the FDIC seized the bank? Not even the bond bullies would get paid then.

Any single-digit stock that holds a significant amount of debt is a sucker’s bet, Cramer said. Lehman, AIG, and now Ford all fit into this category. Shareholders are last in line to get paid if an institution in circumstances such as these fails. And if the government takes over, no one but it sees a return.

Cramer himself learned this lesson the hard way, buying both Memorex, an old computer storage firm, and Charter Communications before they went to zero or close to it.

And that’s the key here. Remember something important about these cheap-looking stocks: No matter how small your initial investment, it can still be wiped out.

So if you’re going to speculate, take a look at the company’s debt first. If it’s as big as Washington Mutual’s, find another stock.

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