CNBC's Jim Cramer explained several methods to help assess risk and reward when picking stocks.

"Know what you own, and know what others will pay for it," Cramer said. "That means you need to understand the risk-reward, the potential downside and potential upside, before you purchase anything, by figuring out where the growth investors put in the ceiling and where the value investors create the floor."

To assess risk, investors need to figure out the downside, or how far a stock could potentially fall. But to assess reward, investors need to figure out the upside, or how much a stock could rally. To Cramer, understanding risk can be one of the most important parts of investing, as he said the pain of a big loss can hurt more than the rewards of an equivalent gain.

Cramer said the upside is determined by how much growth-oriented money managers are willing to pay for a stock, whereas the downside is determined by what value-oriented money managers are willing to pay for a stock on the way down.

To help assess risk and reward, Cramer recommended using a method called growth at a reasonable price, or GARP. This approach compares a stock's growth rate with its price-to-earnings multiple. If a stock has a price-to-earnings multiple that's lower than its growth rate, it's probably cheap, Cramer said. But if a stock has a multiple that's more than twice its growth rate, it's likely too expensive and may not have much upside, he said.

Cramer also suggested investors consider a stock's PEG ratio, or price-to-earnings growth rate, which is calculated by dividing a stock's price-to-earnings multiple by its long-term growth rate.

"Like with any of my methods, or anyone else's for that matter, this one is rough approximation, a bit of subjectivity," Cramer said. "It's useful, especially when you're trying to figure out the risk-reward, but it's not always right. And it only applies to companies that trade on earnings, not unprofitable companies with stocks that trade on sales."

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