3 Reasons to Stop Watching “Mad Money” on CNBC
Jim Cramer’s “Mad Money”, while it can be fun to watch and make you aware of stocks you may not have heard of, it’s not a useful source of investment advice. In the show Cramer seems to place a lot of focus on buying/owning stocks that have good management and prospects with the added caution that you should “do your homework before investing”. Good management and prospects are positives for a company, but hearing Cramer mention a stock on Mad Money does not give you an excuse to risk your money on something you don’t fully understand. While Cramer probably means well and is clearly a very intelligent and knowledgeable investor, too often investors base their decisions on Cramer’s advice without realizing that successful investing takes much more than trading off of stock picks announced on national television. If you’re not already convinced, here are three reasons you should stop watching Mad Money and start thinking for yourself
1. Jim Cramer always says “do your homework”; what on earth does that mean?
If you spend hours listening to company calls, reading through company filings, and comparing companies in the industry, do you think that gives you justification to risk your hard earned money by buying stock in individual companies? The problem with the phrase “do your homework” is that people don’t understand what it really means. For most people this phrase implies doing “fundamental analysis”, or looking into the inner workings of a company and comparing financial ratios. While ratio comparison is an important part of the analysis process, looking at and comparing a bunch of ratios DOES NOT provide a basis for valuing a stock. A stock’s value is based on expectations of future cash flows. While the talking heads on CNBC might make you think that you can simply take an industry ratio and apply it to a stock to establish its value, the reality is that valuing a stock is a much more complex process.
“Doing your homework” is not just knowing a lot about a company. There are already many people out there that know much more about the company than you can possibly learn even if you spent 5 hours a week on just that one company. Their entire job is to know all of the happenings of 10 or even fewer companies. What makes it even more difficult for individual investors is that those people don’t just work 40 hours a week… In other words, if you simply learn a lot about a company you are earning a C on your homework at best.
Really doing your homework involves doing the dirty work that 99% of people can’t or wont do because it is either too difficult, time consuming, or incomprehensible. That means adjusting financial statements yourself, evaluating your own discounted cash flow scenarios based on value drivers, and estimating your own cost of debt and cost of equity. Don’t think for a second that a sustainable edge in stock picking can be gained from just an hour a week of “homework”; a competitive advantage in stock picking is something that is developed over years of hard work, meticulous modeling, and defining a process that works.
2. Being bullish/bearish on a stock is a ridiculous way of saying “I think a stock is going up/down but I have no concrete reason for why”
If a stock is trading at fair value, then in theory that stock should return to shareholders the cost of equity as a total return. If you believe even remotely in efficient markets (stocks generally trade at a level reflecting publically available information), then you can safely say you are “bullish” on most stocks. Why? Because those stocks will have to rise in order to meet their required return on equity based on assumed risk.
When someone says they are bullish/bearish on a stock I typically assume they are making a macro call and then applying it to a particular company. For example, lets say someone thinks that auto sales will be lower in 2014 and therefore they are “bearish” on Ford. Even if they are right about the economic forecast, are they ignorant to the fact that any half decent analyst is already pricing in the possibility of slowing sales into their intrinsic value of the stock?
A proper stock valuation takes into account different scenarios and values the stock according to the probability of those scenarios. If you think there is a 20% chance of a recession in the next few years, you should model the cash flows under these conditions and weight them according to probability in your valuation. This does not necessarily mean you are “bearish” on the stock. What it will; however, allow you to do is look where the stock is trading compared to your own valuation based on the probabilities that various outcomes occur.