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Detecting Dangerous Dividends

Thursday, 23 Sep 2010 | 9:00 PM ET

“When it comes to dividends,” Cramer said Thursday, “size isn’t everything.”

Right now Frontier Communications has the highest dividend yield in the S&P 500—9.3%—but that isn’t necessarily a good thing. In fact, Cramer told viewers a big number like that is most often a red flag. Something investors should use as a warning to steer clear of the stock, that dividend cut may be coming.

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Look deeper and you’ll see that Cramer’s right. Frontier, a rural telecommunications company, already cut its dividend to 75 cents a share form $1 when it closed its massive deal with Verizon on July 1. And “Mad Money” host thinks he heard mumblings at the quarter about another possible cut in the not-too-distant future.

Apparently, management is hoping to achieve investment-grade status on its debt, so it will switch from being a highly-leveraged firm that returns profits to shareholders to one with a more conservative capital structure. The focus then will be paying down debt.

There’s also the fact that Frontier doesn’t earn enough to pay even that cut dividend. Over the past 12 months, earnings have come in at just 42 cents a share. In 2009, it was 38 cents. And even if you go all the way back to 2006, when FTR earned a record 78 cents a share, that wasn’t enough to cover the then $1 payout. As a rule of thumb, Cramer likes a company’s earnings to be twice the dividend, but Frontier right now is offering the reverse.

Cramer’s also worried about Frontier’s ability to successfully integrate the Verizon assets, especially considering they include some of Verizon’s weakest states. He’s seriously questioning where FTR will be able to find the $500 million in synergies it predicted from the deal.

The better play, if you want a dividend-paying rural telco company, would be to buy either CenturyLink or Windstream , which yield 7.4% and 8.1%, respectively. Their businesses are much stronger, and they shouldn’t have any trouble paying those dividends.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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