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The Difference Between a Stock and Its Underlying Company

Cramer wants to help investors make money, so he though it important to reiterate a basic concept about stock picking: Companies are analyzed, but never traded because the company and its stock are never the same thing.

“People constantly make the mistake of equating a company with its stock,” the “Mad Money” host explained. “It’s the kind of mistake that can absolutely wreck your portfolio, especially in volatile markets where many stocks trade off of big-picture, so-called macro data about the broader global economy rather than what’s known as the micro, meaning information about the actual individual companies behind the stocks.”

When a stock gets crushed, Cramer said investors often assume there must be something wrong with the company. Inversely, investors tend to assume the company is doing something right if its stock pops. But many times these moves have nothing to do with the underlying business, he continued.

Increases in the earnings estimates for an underlying company, however, is the important determinant of a higher stock price, as nothing correlates more strongly with a rising stock price than earnings estimates. But there are so many other factors that dictate how a stock moves, Cramer said. All sorts of things could make the stock of an improving company fall while the stock of a deteriorating company rises.

One factor, Cramer said, is the rise of the exchange-traded fund. This is a basket of stocks from a certain sector. As ETFs become more and more popular, stocks in the same sector often trade in lockstep with each other. So good stocks will trade in tandem with mediocre, even bad stocks.

Forced selling is yet another problem, Cramer said. This is when money managers get in a bind and need to raise cash, so they sell en masse, bringing everything else down.

Short selling is another factor, he continued. When lots of shorts pile onto a stock and good news about the company comes along, there will likely be a huge short-squeeze.

Bottom line: What’s happening with a certain stock isn’t’ necessarily a reflection on the underlying company.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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