How to Choose and Hold Best-of-Breed Stocks

TL;DR

Buy well-managed, high-quality industry leaders instead of chasing low-priced stocks that only appear cheap, and remain patient when the underlying business remains strong. Evaluate future earnings, financial strength, brands, management, and long-term prospects, while using diversification and an index fund to reduce the risks of a technology-heavy portfolio.

Transcript

Hey, I'm Kramer. Welcome to Mad Money. Welcome to Kramer. I'll do my friends. I'm just trying to make a little bit of money. My job, not just to entertain, but to educate, to do some teaching here. So, call me 1800 743 CBC Mitch Kramer. The stock market isn't always a friendly place. It can be volatile. It can be painful. It can just be downright d... Read More

Key Insights

• Best-of-breed companies are well-managed, high-quality businesses with strong prospects, valuable brands, sound balance sheets, and dependable leadership. Their stocks may command premium valuations because the underlying businesses are more reliable and less likely to suffer catastrophic failures than weaker industry competitors.
• A low dollar share price is not evidence that a stock is genuinely cheap. Penny stocks, meme stocks, and second-tier companies may deserve their lower valuations because their businesses are worth less, making apparent bargains more likely to produce losses than durable gains.
• A genuine bargain is a valuable underlying business offered at an attractive price. Cramer distinguishes bargain hunting among strong companies from buying weak merchandise merely because its quoted price is low, emphasizing business quality over the superficial affordability of individual shares.
• Patience is essential when a high-quality company's stock temporarily stops working. Individual investors do not face the same pressure as hedge fund managers to report gains every month or quarter, so they can allow a sound long-term investment thesis more time to develop.
• Apple's 2016 decline from a split-adjusted $31 to $23 illustrated the difference between falling price and deteriorating value. Cramer focused on customer loyalty, services revenue, cash, products, and a low earnings multiple, concluding that intense negativity created a buying opportunity rather than a reason to sell.
• Nvidia's performance demonstrated why near-term valuation can misrepresent a best-of-breed growth company. Cramer says its shares repeatedly appeared expensive, but CEO Jensen Huang delivered results above expectations, and the stock later rose more than 800% across 2023 and 2024 after technology's difficult 2022.
• Portfolio diversification requires exposure beyond closely related technology categories. Cramer would support a growth portfolio built around profitable companies if it also included an index fund and at least one clearly nontechnology stock, with two nontechnology holdings suggested for investors in their 50s, 60s, or 70s.
• Forward earnings estimates are more relevant than the current year's price-to-earnings ratio in Cramer's approach. He recommends examining the P/E ratio for both the next year and the following year because longer-range earnings can reveal value that a seemingly expensive near-term multiple obscures.

Questions & Answers

Q: What makes a company best of breed for investors?

A best-of-breed company is a well-managed, high-quality business with strong prospects and valuable underlying assets. Cramer's examples emphasize dependable leadership, a sound balance sheet, respected brands, customer loyalty, growing business lines, and a record of delivering strong results. Such companies may trade at higher price-to-earnings multiples, but their superior business quality can justify the premium and reduce the danger of a disastrous investment outcome.

Q: Why should investors avoid choosing stocks by low share price?

A low share price does not prove that a stock is undervalued. Cramer warns that penny stocks, meme stocks, and second-tier companies often look cheap because their underlying businesses are weaker and genuinely worth less. Buying them solely for their low quoted prices confuses affordability with value. A real bargain is a worthwhile business selling below its long-term worth, not poor-quality merchandise carrying a small price tag.

Q: Should investors pay a premium for high-quality stocks?

Investors can reasonably pay a higher valuation for a high-quality industry leader because the premium reflects stronger management, assets, brands, prospects, and reliability. Cramer argues that best-of-breed stocks are generally less likely to blow up than lower-quality alternatives. The price should still be considered carefully, but an apparently expensive leader can become a better long-term investment than a cheap competitor whose weaker business deserves its discounted valuation.

Q: When should an investor hold a falling stock instead of selling?

An investor should consider holding a falling stock when careful research still supports the underlying business, its assets remain valuable, and the long-term investment story has not materially changed. Cramer says temporary price weakness can pressure investors into abandoning genuine value. Individual investors can wait through periods without immediate gains because they do not need every position to perform each day, month, or quarter, although conviction should rest on homework rather than hope.

Q: What investing lesson came from Apple's 2016 decline?

Apple's decline from a split-adjusted $31 to $23 in 2016 showed that a falling price can create an opportunity when business quality remains intact. Cramer evaluated its low earnings multiple, customer loyalty, services revenue, cash position, and products rather than accepting widespread pessimism. He concluded that selling would mean giving up on value, while buying at the discounted price offered exposure to a best-of-breed company before a major advance.

Q: What did Nvidia demonstrate about valuation and patience?

Nvidia demonstrated that a stock appearing expensive on near-term price-to-earnings measures can ultimately prove inexpensive when the company repeatedly produces results above expectations. Cramer attributes that execution to CEO Jensen Huang and describes Nvidia as a long-standing best-of-breed company. After technology struggled in 2022, maintaining the position through pessimism preceded a gain of more than 800% over 2023 and 2024, supporting his advice to own it rather than trade it.

Q: How should investors evaluate a company's P/E ratio?

Cramer recommends focusing on forward price-to-earnings ratios for the next year and the year after, rather than placing heavy weight on the current year's figure. He calls those later periods the out years. This approach examines how expected earnings may change over time and can reveal why a growth company such as Nvidia looks expensive in the near term while presenting a more attractive valuation based on subsequent earnings.

Q: How can an investor diversify a technology-heavy portfolio?

A technology-heavy investor should pair individual growth holdings with an index fund and add at least one stock that is clearly outside technology, according to Cramer. He notes that technology represents roughly 26% to 30% of the S&P, so dividing holdings among software, semiconductors, data centers, advertising, and related areas may still leave substantial sector concentration. He suggests two nontechnology stocks for investors in their 50s, 60s, or 70s.

Summary & Key Takeaways

• Cramer argues that disciplined investing helps minimize losses and maximize gains in both favorable and hostile markets. His central rule is to favor well-managed, best-of-breed businesses with strong prospects, valuable brands, sound balance sheets, and proven leadership, even when their stocks carry higher price-to-earnings multiples than lower-quality competitors.

• A low share price does not automatically represent value. Penny stocks, meme stocks, weak companies, and poorly vetted cryptocurrencies may look affordable while offering inferior underlying assets. Genuine bargains arise when a valuable, high-quality business trades below its long-term worth, as Cramer says occurred with Apple during intense pessimism in 2016.

• Patience matters after identifying a high-quality company whose business story remains credible. Individual investors do not need every holding to produce immediate monthly or quarterly gains. Cramer recommends studying earnings expectations for the next year and the year after, maintaining conviction when the fundamentals remain sound, and diversifying concentrated technology portfolios.