Hot stocks keep the investing game exciting, but eventually the party ends. The goal, of course, is to take profits before that happens, but the question is when exactly to do so. Cramer on Friday offered a great way to get out near the top.
First, though, readers should know that by “hot stocks” Cramer means small, speculative companies with low market capitalizations. These names typically start out with little analyst coverage and have the potential to run for years.
So if you were in on such a run, when do you sell the stock? Once four analysts are covering it. That’s the point at which interest has peaked, Cramer said, and the momentum has all but been exhausted.
Hot stocks lose their steam when there’s nobody left to buy them. They come virtually out of nowhere, attracting more and more attention until everybody who wants in is in. When that happens, Cramer said, the party’s over.
Take Hansen Natural , for instance. This was the hottest of hot stocks, Cramer said, throughout 2004, 2005 and the first half of 2006. HANS soared, split adjusted, to $200 in July 2006 from $18 in early 2005.
Now, the company’s five-for-one split certainly encouraged investors to sell, which is one reason HANS peaked that July. But Cramer thinks another factor was at work as well: Goldman Sachs initiated coverage on May 10, 2006 – and it was the fourth brokerage house to do so.
Sure, HANS continued to move higher even after Goldman made its call, but the smart money took profits before the peak. Better to lock in those gains than watch them slip away.
It’s true that some momentum names recover and hit new highs – and HANS did just that in 2007 – but they rarely reach the same level they did on their first run. Once the stock is overcrowded with investors, it just runs out of gas.
“And there's just no way to refuel,” Cramer said.
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