Mad Money

1 of the Most Crucial Elements of Investing

One of the most crucial elements of investing, Cramer said Tuesday, is determining which stocks are cheap and which are expensive.

Take AT&T and CenturyLink , for example, a $29 and $37 stock respectively. The share price is meaningless, though, because when you buy a stock, you are paying for the company’s future earnings stream. So Cramer recommends looking at the earnings-per-share estimates for next year and the price-to-earnings multiple, which indicates how much investors are willing to pay for those earnings.

AT&T sells for 12 times earnings while CenturyLink sells for 14 times earnings. At first it appears CenturyLink is slightly more expensive. Then again, CTL pays a 7.8 percent dividend yield while T yields 5.9 percent. So with a higher yield, it makes sense investors should pay up for CTL.

Based on earnings and dividends, both T and CTL have comparable valuations and neither seems more or less expensive — at first. But to Cramer, AT&T is less expensive by far. While both may have similar multiples, Cramer explained that the quality of the merchandise is very different. Just compare the multiple to the growth rate — when growth prospects are factored in for each stock, CenturyLink is roughly 7 times as expensive as AT&T.

“CenturyLink may look attractive at first glance given that it has a comparable multiple to AT&T with a higher yield, but when you look under the hood, there's no growth here,” Cramer said, adding he doesn’t think the extra yield is worth the extra fright. “So why not go with AT&T instead with it's wireless growth, safe dividend, and the possibility of a game-changing T-Mobile acquisition?”


When this story was published, Cramer’s charitable trust owned AT&T.

Call Cramer: 1-800-743-CNBC

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