Mad Money

Cramer Remix: My warning before buying this sector

Cramer Remix: Why investors should be wary of stock buybacks
Cramer Remix: Why investors should be wary of stock buybacks

Jim Cramer has seen that there is an entire industry of commentators and pundits out there who are devoted to telling investors that it is not possible to beat the market. They say that you can't win, so it's better to just dump your money into an index fund that mirrors the market than to invest on your own.

"I think that's garbage. You can beat the averages as long as you know what you're doing, using the precepts that we teach every night here, and this is particularly important to keep in mind after a selloff period," the "Mad Money" host said.

That is why Cramer spends so much time educating investors about stocks, because he knows that if you do your homework, you can pick your own stocks. That means being able to identify opportunities and avoiding the worst mistakes in investing, especially when the market becomes a battlefield.

One of the most important lessons that Cramer learned over the years is don't trust all buybacks.

"They aren't created equally and they aren't all a place to run to in a selloff. In fact, many buybacks disappear when times get tough and can't be relied upon as we saw when the oils came crashing down when oil plunged in 2014," Cramer said.

Buybacks are when companies repurchase their own shares on the open market in order to take them out of the equation, thus reducing the number of shares outstanding and boosting the earnings per share. Often buybacks are used as a way for companies to reward shareholders with their cash. However, Cramer likes dividends more because of the downside protection and preferred federal taxation status.

Over the years, buybacks have become very popular. Companies spent about $1 trillion more on buying back stock than on paying dividends in the past decade. Unfortunately, Cramer has seen that these buybacks have not given shareholders the value that they expected.

"So, when you see a company with large buybacks and a puny dividend, you should be suspicious rather than bullish," Cramer added.

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One of the worst myths out there is that the market is always rational and makes sense. Cramer knows this is not true; on any given day the market can be totally wacky for reasons that do not make sense. Sometimes stocks go up when they should have gone down, and sometimes entire sectors move for ridiculous reasons.

"Never assume that just because something happened, it has to make sense because the market is always supposed to make sense. That's nonsense," Cramer added.

It is important to be able to look at some of the crazy moves and understand that the stock moves are just nuts. Because once you start cooking up connections where none exist—Cramer says that is where you are really in trouble, because you can make yourself believe just about anything.

So, what are some of the crazy catalysts that move stocks?

They are all reasons that have nothing to do with the underlying prospects of actual companies. When that happens, Cramer recommends taking advantage of that irrationality, not to buy into it by chasing stocks or panicking out of them.

Read More Cramer: Worst mistake you can make in a selloff

But in a market-wide correction where everything under the sun is sold off, how do you know the difference between a broken company that's not bouncing back and a broken stock?

That is exactly why Cramer recommended that when you are in the middle of a selloff, the first thing to do is to look at the companies that caused it—they are probably broken.

"If you're looking at a company that is part of the reason for a correction, you're looking at a broken company. Those are directly in the blast zone and certain to be obliterated," the "Mad Money" host said.

Another thing that Cramer thinks is important to keep in mind is that a company does not break just because its stock goes lower. Investors saw this in 2012 when domestic companies were brought down just because of turmoil in Europe. How could a Mexican restaurant chain like Chipotle take a hit because of Italian bonds? It happened.

Stocks like Chipotle went down because all stocks were going down at the time, not because it had a connection to the selloff.

"To put it another way, you don't want to buy the stocks that are leading the decline when you're looking for opportunity in a selloff. You want to look for stocks in areas that are independent of what's ailing the market," Cramer said.

Read More Cramer: Avoid these horrifying stocks in a selloff

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The first step to conquer a selloff is to circle the wagons around the stocks in your portfolio that you really like, and then leave the ones that don't inspire you in the dust. The "Mad Money" host thinks it is a good idea for investors to know the difference between a damaged stock and a damaged company when hunting for bargains during a selloff.

"A correction is just a megasale on stocks—no different than what you might find on all kinds of things at your Sam's Club any day of the week," Cramer said.

After those steps are covered, it's time to get into the nitty gritty of the specific types of stocks that Cramer scoops up during a downturn. And the good news is that the more brutal the selloff is, the more attractive these stocks will look.

First, Cramer likes to look for stocks that have pulled back from their highs during the selloff. The new high list is always a great place to start looking. But stocks on that list also tend to be expensive, which is exactly how a big decline helps.

So if you get more conservative, the best bet is to go for stocks that will practically guarantee money in your pocket. That is exactly what a dividend does.

Ultimately, Cramer considers a selloff as an opportunity to buy some of the best stocks out there, especially those that have just pulled off their highs and stocks that have fat yields thanks to the decline. Those are the best places to bargain hunt in a decline.

Read More Cramer: Money magnet stocks to buy in a selloff

However, in order for stocks to move higher they will need to have cash to fuel a rally. Sometimes that fuel can come from retail investors who have been waiting on the sidelines and ready to put that cash to work.

"When money is flowing into stocks, with the mutual funds buying in endless waves and the hedge funds desperate to won stocks rather than shorting them, then you're in the land of the thousand bull dances and you don't have to worry about where the fuel for a rally is going to come from," Cramer said.

However , when there's no money flowing into the market, Cramer has seen that powerful moves in stocks and sectors can occur. This is because when investors are reluctant to invest, money will be pulled out of the least exciting groups of stocks and rotate into sexier names with more lift.

But here is the problem with rotations: Without new money flowing in, gains often become zero-sum and will run out of fuel. The leaders will run out of steam with nothing to drive them higher, and that's when the worst possible rally can occur—a rally in the wrong stocks.

Cramer often sees that stocks that signal a slowdown or recession—such as the food and drug names—become the market's new leaders.

"You never really want to see any of the consumer staples roaring higher in a sustained advance because it means people think the economy's going to either get worse or simply stay in awful shape for a long time to come," Cramer said.