Ka-Booom!

By James J. Cramer

The stock you bought dropped 30% yesterday because it failed to meet Wall Street's exacting expectations. Ouch--you've just been scalded by what we call an earnings blow-up. Now what? Do you lie there inert, screaming "Where's the rest of my stock?" Nah. In the trenches of capitalism where I toil, one of these high-explosive blow-ups hits me monthly, obliterating any hope of a quick profit, or perhaps producing a staggering unrealized loss. IBM, Xerox, Unisys and Lexmark have all detonated recently. First, take heart. You aren't the only one dumb enough to bet on a great company during a period of unsettling sales growth and a Fed turned hostile to higher stock prices. If you haven't taken a hit in your personal portfolio, you can bet that your mutual-fund managers have their own shrapnel collection.

The next thing you do is find out why the company failed to meet expectations. If you read anything about accounting irregularities being behind the disappointment, then you pick up the phone, or go to your computer, and turn that unrealized loss into a realized loss, pronto. My rule is simple: companies nailed or fessing up for bogus numbers can't be owned. Many never come back. Waste Management, HBO McKesson, Sunbeam--these were all worth booting the moment the accounting problems surfaced. Don't try to rationalize or waffle. Just...get...out.

If, on the other hand, the problem appears to be a onetime event--a key part didn't get delivered in time, or demand outstripped supply--buy more. Apple Computer lost about 15 quick points when it preannounced that it couldn't meet consumer demand for its hot new computers. That was a classic buying opportunity created by Apple's components suppliers, who let the company down. When the parts reappeared, so did the Street.

Unfortunately, most blow-ups are a combination of factors that don't easily line up in those two camps. Say demand has slowed for a product. If the item is tech, that's nasty. It means you will probably have to take the hit--unless you can wait for a new product cycle. If one is just around the corner, I use the break to buy more, as I have often done with Intel. If the next product looks hopelessly stalled or way out in the future, I take a pass.

Not sure whether the issue is a supply problem or just sloppy execution? Wait a month, if not a quarter. Silence in this case is golden, because most companies would not take the extreme measure of announcing a shortfall if they had any hope, near term, that there could be a turn in fortunes. In other words, as bleak as things are, these companies usually take this extraordinary step because they believe things are even darker in the near term, and they don't want to mislead.

A company that has made you money in tough times deserves another shot. Usually, by the time it announces the next quarter, it has either cleaned up the mess or taken steps to rectify the problems. If there is no improvement and no steps have been taken by that next earnings release, I move on. But positive steps or outlook get rewarded with a buy--thus averaging down the cost.

No matter what, do not be shamed by a sudden decline. This is business; it happens. Stocks are not like vacuum cleaners. They have no warranty. They cannot be returned. But they can regain lost value, or at the very least be sold to the next sucker.

Cramer, a hedge-fund manager, writes for theStreet.com He is long on Intel. This column should not be construed as advice to sell or buy stocks