You must understand this about stock yields

Friday, 21 Feb 2014 | 6:01 PM ET
Dividends work: Cramer
Monday, 5 Aug 2013 | 6:40 PM ET
Mad Money host Jim Cramer is digging into just what your portfolio needs. In this segment, he explains why you need to own at least one high-yielding stock, if not multiple.

(Click for video linked to a searchable transcript of this Mad Money segment)

When you hear about high yielding dividend stocks, you'd think the bigger the yield the better. After all, who doesn't want greater return.

But that's isn't always the case, says "Mad Money" host Jim Cramer.

The issue with dividend yield is the way it's calculated which is annual dividends per shared divided by price per share.

Confused? It's easier to understand by looking at it.

Annual Dividends Per Share
Price Per Share

Of course, higher dividend yields may be a positive sign - that is, a sign that dividends are robust. When that's the case, as dividends increase, the numerator in the fraction above increases and yield goes higher.

That's a good thing.

However, there's another way for yield to increase – and it generated by a murkier catalyst. An increase in yield can also be generated by declining share price.

That's not as good.

If share price goes down, the denominator in the fraction above goes down and as a result yield goes higher.

"I call the latter, accidental high-yielders," said Jim Cramer. "These are stocks that yield more than 4% not because of dividend increases, but because their share price has fallen far and fast, causing the yield to skyrocket."

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Accidental high yielders require research, Cramer added. If shares have fallen for a reason that seems temporary – then they're probably a buy.

However, if share price has slipped for a reason that's unclear, then despite the big yield, the stock may be too hot to handle.

Call Cramer: 1-800-743-CNBC

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