Mad Money

Cramer’s No. 1 sign that a stock is too dangerous

How to know a stock is too dangerous

Jim Cramer reminded investors that when they see a stock with an absurdly high yield, they need to stay the heck away from it.

"I don't care how tempting the dividend looks or how cheap the stock seems. A super-high yield that is totally out of whack with its peers is almost always a sign that something is very, very wrong and you need to run, not walk away as fast as you can," the "Mad Money" host said.

A classic case of this is with Frontier Communications, a small telecommunications provider with a monstrous 14.6 percent dividend yield that closed at $2.76 per share on Monday.
The stock might seem tempting, but buying a stock for that big of a yield is almost always a mistake.

The key, Cramer said, is to figure out how Frontier became a $2.76 stock with a 14.6 percent yield. The answer is that the share price was crushed. After peaking around $8 in 2015, the stock has lost more than two-thirds of its value.

Watch the full segment here:

Cramer’s No. 1 sign that a stock is too dangerous

Frontier managed to rebound from late 2013 to early 2015 when it seemed that the demand for fast internet service was lifting everyone in the group. The company spent millions upgrading its network, but then decided to buy Verizon's California, Texas and Florida wireline business for $10.5 billion in cash and the assumption of $600 million in debt.

This was just a few years after Frontier bought Verizon's wireline operations in 14 other states in 2010 for $5.3 billion. Verizon would not have sold its wireline business if they thought it was worth owning, Cramer said. In the end, Frontier spent more than $15 billion buying declining assets.

After reporting positive earnings in the fourth quarter of 2014, a big decline began. Yet despite the decline, many analysts continued to remain bullish about Frontier's ability to keep paying its dividend and turn the business around.

The truth, Cramer said, is that Frontier was simply fighting the rising tide of popularity of mobile, and it all came to a head when the company had an ugly top and bottom line miss in November. That was when analysts finally downgraded the stock.

Again, Frontier reported a shortfall in earnings in its most recent quarter, a 12 cent per share earnings loss when analysts were only looking for a 5 cent loss, weaker-than-expected revenue, and a large cut to the full year free cash flow forecast for 2017.

While the 14.6 percent yield could seem compelling to some, Cramer warned that the dividend is only compelling if Frontier can turn things around. If its sales and earnings continue to decline, sooner or later the dividend will have to be cut.

A year ago, Frontier had nearly an 8 percent yield. An investor who bought the stock then would have received its 42 cent annual dividend, but the share price dropped from $5.79 to now $2.76. The losses would have overshadowed anything an investor received from the dividend.

Cramer added that the management at Frontier isn't the problem; the company is just stuck in a terrible industry, the wireline phone business, which is in a long-term decline. He said to use this story as a means to know what red flags to look for.

"Chasing super high yielders is a dangerous game. A sky-high yield is almost always a sign that something is wrong," Cramer said.

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