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Cramer: This Is a Great, Reliable Way to Make Money

Friday, 15 Feb 2013 | 6:00 PM ET
Dividends Make Cents?
Mad Money host Jim Cramer explains why a diversified portfolio should be made up of at least one high-yielding stock.

There's an investment strategy that Jim Cramer calls "one of the greatest, most reliable ways to make money out there."

"Own dividend paying stocks, " Cramer said.

Other investments may seem sexier but Cramer doesn't care. "Dividends make you money," Cramer said. "Since January 1926, roughly 40 percent of the return from the S&P 500 came from reinvested dividends. Never forget that."

(Having trouble viewing the video? Click here!)

And Cramer's favorite way to harness this thesis is to buy dividend-payers that are high-yielding.

Of course, that metric can be a little dicey. You'd think the higher the yield the better the stock, but that isn't always the case.

That's because dividend yield is calculated by taking annual dividends per share and then dividing it by price per share.

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

Annual Dividends Per Share
Price Per Share

The issue is that yield can increase for two reasons 1) if dividends go up -- a good thing or 2) price per share goes down - not a good thing.

And it's key to understand which is driving the increase in yield.

Teresa Guerrero | E+ | Getty Images

So what do you look for to tell if the dividend and the dividend yield are favorable?

"First, above and beyond everything else, we look at the earnings per share; my rule of thumb is that if a company has earnings that are greater than twice its dividend payout, we know it can sustain the dividend even in lean times when the earnings shrink. In that case you're home free; the dividend is secure," Cramer said.

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"If not, you need to go to step two, look at the cash flow, especially important when dealing with companies that have a lot of machinery or other heavy capital investments which cause them to report high depreciation and amortization costs-think high-yielding telco players like Verizon and AT&T, as communications networks don't come cheaply."

These depreciation and amortization costs don't come out of a company's actual cash, but they do skew the earnings lower, which is why the cash flow can often give you a better idea about the health of a company.

"Finally, you have to look at the balance sheet to make sure there isn't a lot of debt coming due in the near future that could necessitate a dividend cut or drive shares lower," said Cramer.

We know that's a little confusing, but it's important to digest and understand.

And it's also important to note that a rising yield because of a falling stock price isn't necessarily unfavorable. Cramer calls these stocks 'accidental high yielders.' If the share decline seems temporary, Cramer likes the risk/reward.

Again, that's because reinvested dividends are "one of the greatest, most reliable ways to make money out there," said Cramer. "And high yielders can be a turbo-charged ways to do it."

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

Questions, comments, suggestions for the Mad Money Web site? madcap@cnbc.com

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