Cramer's 'Mad Money' Recap: Invest Like a Pro
Cramer said every correction has a cause. In 2008, it was mortgage-backed bonds while in 2011 it was the debate over the debt ceiling and the resulting U.S. debt downgrade. Cramer said investors can look for the companies responsible for the corrections and assume they're probably broken companies.
In 2008 that meant banks and everything associated with housing and mortgages were bad. In 2011 it meant any company that would suffer big in another economic slowdown was to be avoided.
Cramer reminded viewers that a company only becomes broken when the reason for liking it goes away, not when the stock price goes lower. The latter case, he said, is a buying opportunity, while the former are the toxic companies that must be avoided at all costs.
Cramer's third lesson for investors was an outline of which types of stocks he looks for in a big market pullback.
Cramer said he first looks for stocks that have recently pulled back from their highs. He said stocks on the 52-week-high list don't get there by accident and while these names are often seen as expensive, they're probably worth it.
Occasionally, a stock will fall from the 52-week-high list for a good reason, such as a missed quarter, but more often it will take a big market correction to rattle these high-fliers. Those are the names Cramer said investors should look for.
Second on Cramer's list are stocks with high dividends. Dividend stocks aren't sexy like high-growth tech stocks, but in a downturn dividends play an important role. They act as a cushion underneath a falling stock because as the stock price falls, the dividend yield -- the amount the company pays as a percentage of your investment -- goes higher. This makes dividend stocks more attractive the more its price declines.
Cramer said his rule of thumb for determining whether a company has a safe dividend that's not at risk of being cut is whether that company earns more than twice the amount of its dividend. If a company's earnings can pay for its dividend twice over, investors probably have a winner.
Caveat on Buybacks
Cramer's next lesson: buybacks. Stock buybacks, which are programs where companies buy back their own shares to reduce the share count and thereby boost earnings per share, used to be regarded as a winning strategy, he said.
In fact, between 2005 and 2011, companies in the Standard & Poor's 500 spent $2.24 trillion buying back stock, significantly more than the $1.4 trillion spent on dividends.