GO
Loading...

Few Things Do More Harm to Portfolios Than ‘This’

Monday, 4 Mar 2013 | 6:31 PM ET
Dividend Cuts Unforgivable Offenses?
Mad Money host Jim Cramer explains when and why you need to beware of falling dividends, saying CenturyLink was crushed when its dividend cut was announced.

"Right now we are in a very forgiving moment, where companies can miss numbers and see their stocks rebound. Where Boeing can have its signature new plane grounded by the FAA and still be within striking distance of its 52-week high," Jim Cramer said.

But there are still some unforgiveable offenses in the market.

And if there's one thing that can shred profits with little or no hope of recovery, it's a dividend cut.


"The bigger the cuts, the worse the damage. That's why, whenever you own a high-yielding stock, whenever you even think about buying something with a sky-high yield, you have to beware of falling dividends," Cramer said

Consider the tragic case of Atlantic Power (TICKER: AT).

The stock had a 10% yield back on February 26th when a caller asked Cramer for insights. The Mad Money host said homework was definitely in order because a sky-high yield can be a trouble sign.


Emrah Turudu | E+ | Getty Images

"Most utilities give you yields in the neighborhood of 4%, so when I see a name like Atlantic Power yielding 10%, it raises alarm bells," he explained.

Sure enough, at the very end of the month Atlantic Power announced a massive dividend cut.

"And it was much worse than the cut that analysts had been expecting. Shares dropped 40% in less than a week. Anybody who owned that stock is now toast," Cramer said.

Although the story sounds somewhat tragic Cramer said there is a silver lining, at least relatively. "Nobody needs to be blindsided by a brutal dividend cut. There are signs that can warn you it's coming well in advance of when it actually happens, and when you see these signs, you need to sell the stock," Cramer said.

--------------------------------------------------------------------------
More from Mad Money with Jim Cramer
Game Plan: What's On Cramer's Radar?
Home Depot or Lowe's - The Better Recovery Play?
5 Dow Dynamos Should Drive Dow Further
--------------------------------------------------------------------------

Atlantic Power was practically a text book case, Cramer said. Following are some tell-tale warning signs.

1. As we mentioned above the 10% yield seemed far too big for an ordinary utility.

2. The payout ratio, the percent of the company's cash flow being used to fund the dividend, was also way too high. "In 2012, Atlantic Power had a 100% payout ratio, meaning every penny of cash they made was used to fund the dividend. That kind of behavior is simply not sustainable," Cramer said.

3. Atlantic Power was losing money. "When the dividend is bigger than the earnings, that should tell you to beware, because either the earnings will have to grow dramatically, or the dividend will rapidly become unsustainable."

4. Late last year Atlantic Power said contracts were expiring over the course of 2013, and cash flows from these projects would be substantially lower after those contracts ended.

Had you read these tea leaves, Cramer said you would have seen the future.

And Cramer said the same was true for CenturyLink, a telco provider that slashed its dividend in mid-February. "Again, there was no reason why you needed to experience that pain," Cramer said.

That is, there were warning signs that should have been interpreted as a sell signal.

1. For two years in a row, in 2011 and 2012, CenturyLink's dividends exceeded its earnings per share. "You can only get away with that for so long before it becomes unsustainable."

2. CenturyLink struggled with capital expenditures and labor contract issues.

"Please, I'm begging you, whenever you think about owning a stock with a high yield, always do the homework to make sure the dividend is safe," said Cramer. "You do not want to get caught in the crossfire if that dividend is about to be cut. In most cases, all the signs are there, you just needed to do the homework and piece them together."

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

Questions, comments, suggestions for the "Mad Money" website? madcap@cnbc.com

  Price   Change %Change
BA
---
ATP
---
CTL
---

Featured

Contact Mad Money

  • Showtimes

    Monday - Friday 6p ET
  • Jim Cramer is host of CNBC's "Mad Money" and co-anchor of the 9 a.m. ET hour of CNBC's "Squawk on the Street."

Mad Money Features

  • Grab the latest CNBC gear from the NBCUniversal Store!

  • Get a behind-the-scenes look at how Cramer formulates his investment advice. "Inside the Madness" is a column, which features e-mails and more with Cramer and his researcher Nicole Urken.

  • You’ve always wanted to hit the “Hallelujah!” button. Here’s your chance.