This has certainly been a tough market in recent weeks. One day, stocks rose on renewed expectations that the Fed would cut interest rates in December. The next day, they are troubled by concerns of an impending AI bubble. It’s no surprise that the CBOE Volatility Index (VIX), widely known as the “fear index,” rose in November, reaching its highest level since President Donald Trump’s “Emancipation Day” in April. Of course, there are always down days in the market. But they are especially frustrated when the data doesn’t seem to support price movements. After all, 83% of S&P 500 companies that have reported so far have exceeded street earnings estimates, and 76% are coming off strong quarters, beating earnings estimates. But that success has been met with relentless sales, including some of the best-performing companies. Although their behavior can be frustrating, they also tend to present opportunities. Investors just need to know where to look and how to strategically utilize their funds. To help you in your search, we’ve come up with six questions to ask yourself during a difficult tape. Your answer will determine whether you protect your stocks, maintain your current exposure, or hold back and buy more. 1. Have there been any changes in the company or industry that could impact future earnings?We focus on fundamentals. In other words, we care far more about a company’s financial health and earnings prospects than we do about its stock price. It’s not always easy. Price action shows how much money is made or lost on a particular day. However, for long-term investors, it’s important to maintain maximum focus on long-term profitability. Legendary investor and economist Benjamin Graham once said: “In the short term, the stock market is a voting machine.” Over the long term, stock prices tend to track company performance. Of course, if for some reason you decide your investment thesis is broken, you may not want to stick to it at all. Bad news may be priced in and stock prices may overreact. A negative update by itself does not mean you should sell the stock. However, it still means you need to objectively re-evaluate whether you want to participate. On the other hand, if after analyzing both the company’s own merits and industry-level changes such as regulatory changes, you conclude that the long-term earnings story is intact, you may find a buying opportunity if the stock price declines. First, answer a few more questions. 2. From a macroeconomic perspective, have there been any changes that might affect investors’ willingness to pay for the company’s earnings?The first question concerns earning power. However, that is only one part of determining the value of a stock. That is a bottom-up perspective. Here we need to consider a top-down perspective. This will help you see how much multiple investors are likely to pay for the revenue outlook you determined in the previous question. Consider adopting a worldview that incorporates everything from geopolitical events to monetary and fiscal policy to macroeconomic data points. From there, you can understand what this worldview means for different sectors of the economy and companies in those sectors. Using this top-down analysis, the aim is to determine whether there have been changes that may impact the economic outlook, which in turn affects sentiment and, in turn, whether multiple (or discount) investors apply to their valuation models for the foreseeable future. Are inflation expectations rising, prompting the Fed to raise or stop cutting rates? In that case, we would expect the multiples on our earnings estimates to decrease or the discount rate applied to future earnings to increase. Layering this analysis helps determine a price target for a stock. Ultimately, the target price is simply the earnings per share (EPS) multiplied by the number of investors willing to pay for that earnings. Where the stock trades relative to the new target price will determine the course of action. However, to further refine your price target, you need to take one more step. 3. What is the multiple relative to both the stock’s historical valuation and the market? Once you have a sense of whether the multiple should expand, contract, or stay flat given a top-down perspective, consider what that means historically and how it compares to the market as a whole. This means you need a frame of reference. It is usually the multiple at which the stock has traded in the past relative to itself, its peers, and even the market as a whole. Don’t forget to factor in growth rates (we use PEG multiples for this) and changes in investor sentiment. This could cause investors to pay up or value their gains lower than they were before, all else being equal. By answering the second question, you determined your opening price goal. This third question aims to narrow that goal and solidify your thinking based on the stock’s historical valuation dynamics. The purpose is to understand how the story has changed in relation to history and to determine whether investors should pay the same amount, the same amount, or less than they used to, given the current situation. It is not enough to simply determine how much the multiple will grow or shrink. The amount of expansion or contraction must also be considered. Take Wells Fargo, for example. We argued that the multiple would increase further once regulatory milestones are achieved. That’s great, but by how much? To determine that, we can look at the situation before the regulatory issue arose, but that was a long time ago. We argue that it makes more sense to look at the trading prices of well-run banks and take that as an indicator of where multiples are going. For example, you might look at JPMorgan and use that multiple as your upper limit, considering it is considered the best in the industry. From there, we’ll adjust based on the multiples we see for other companies like Bank of America and Citigroup, and use these three valuations to try to determine where a reformed Wells Fargo deserves to be traded. 4. What does the chart tell you?Once you have an idea of the price level at which to buy further shares, taking into account the fair value estimate generated in steps 1 to 3 (this is the target price, or fair value estimate), it is worth looking at the chart to determine possible support levels. There are many tools for technical analysis, but with an emphasis on bottom-up analysis, I prefer to keep it simple or leave it to true market technicians, as Jim Cramer often does in “Mad Money.” You need to see where the 50-day and 200-day simple moving averages intersect, long-term trend lines, horizontal support lines, etc. Additionally, pay attention to volume. Higher volume means that the movements you’re analyzing have more weight because they were made with more participants. You may also consider tools such as the Relative Strength Index, which is a momentum indicator that helps indicate whether a stock is reaching oversold or overbought levels. If you see support coming in at key levels that have historically attracted buyers, you may want to buy more shares. However, if the chart shows that long-term support is not holding (for example, if the stock drops further after falling below the 200-day moving average), hold back because the stock could be a “falling knife” at that point. In these cases, for fundamental reasons, you decided that you still wanted to be involved in the early steps, so you need to be patient until you get a better price level. Wait for the sell-off to slow down, wait for the stock price to stabilize, and possibly regain some ground before intervening. 5. What is your current position? Once you have your purchase level in mind, you need to decide how much money you want to commit. Think in terms of percentage weighting of the total portfolio, including cash. For the club, full positions range from 5% to 6%. This means not adding to names that have a weight of 5%, but trimming names that start increasing beyond 6%. How aggressively you should act depends on what the complete position size is for you and how large your existing positions are already. If the position is new and the current weight is low, you may be able to be a little more aggressive, knowing there is still room for further weakness. If your position is of a relatively good size, say 50% or more of the total weight, consider waiting for a larger decline so that each purchase can have a greater impact on reducing your overall cost basis. 6. Are there any catalysts in the near future?The last thing to consider before making a trade is future events. Having taken into account all the information we can, we would like to consider what updates are coming in the future and how much they may impact our investment thesis. Consider upcoming triggers that could become more aggressive, such as upcoming economic indicators or the resolution of a legal dispute. Not all events are treated equally. For example, we tend to be cautious before quarterly results. Even if you measure headline numbers correctly, predicting investor reaction to an announcement is another challenge entirely. If you look at Nvidia, they reported a chaotic quarter and immediately suffered a decline. (See here for a complete list of Jim Cramer Charitable Trust stocks.) As a subscriber to Jim Cramer’s CNBC Investment Club, you will receive trade alerts before Jim makes a trade. After Jim sends a trade alert, he waits 45 minutes before buying or selling stocks in his charitable trust’s portfolio. If Jim talks about a stock on CNBC TV, he will issue a trade alert and then wait 72 hours before executing the trade. The above investment club information is subject to our Terms of Use and Privacy Policy, along with our disclaimer. No fiduciary duties or obligations exist or arise from your receipt of information provided in connection with the Investment Club. No specific results or benefits are guaranteed.
