Rule #4: "Don't believe the hype"
Not all upside surprises are worth getting excited about, Cramer said. If a company reports quarterly results that show its earnings-per-share are higher than what the average analyst on Wall Street had expected, then all of the headlines will describe it as an upside surprise.
"Stocks are supposed to go up when the underlying companies they're attached to deliver higher earnings than anyone had expected," Cramer explained. "But what the headlines call an upside surprise and what truly impresses the professionals in a quarter are two different things."
Headline writers don't draw a distinction between a high quality upside surprise and a "low quality, illusory" upside surprise, Cramer noted. Investors can tell the difference, though. A high-quality upside surprise is generated by high-than-expected sales, which leads to better-than-expected earnings per share. Improved sales means the industry is improving and more people are buying the company's products or it could mean that the company is taking market share. Either way, it bodes well for the company.
On the other than, a low-quality upside surprise is based purely on a better bottom line (earnings per share) than the top line (the sales number). In this case, the upside surprise is not generated by improved business, but because management cut costs, changed their accounting practices or bought back shares. None of these things matter to Wall Street analysts, though. Instead, they want to see a company's ability to deliver better-than-expected sales.
Continue reading for Rule #5.