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How Cramer Uses Earnings Reports

On Monday, "Mad Money" host Jim Cramer detailed how he uses a company’s earnings report, a tactic he recommends all investors do.

“I measure the stock’s earnings growth and its quality of earnings growth against its cohort,” Cramer said. “Then I figure out whether its cohort is worth owning or forgetting about.”

After all, the sector is an important issue to consider when picking stocks. Historically, a stock’s sector had accounted for 50 percent of its performance. Today, though, many people invest by using exchange-traded funds. In turn, the sector has superseded earnings at times.

(RELATED: Cramer: 4 Earnings to Watch Tuesday)

Take bank stocks, for example. Many investors trade the Financial Select Sector SPDR, the ETF that encompasses many bank stocks. If a certain bank stock is apart of the XLF, but then people don’t want to buy that ETF, then it really doesn’t matter what kind of earnings results the bank posted. The bank stocks will largely trade in tandem because they are being pulled up or down by the XLF.

For this reason, Cramer has had to dismiss earnings per share gains when the cohort was radically out of favor. Instead, he tries to determine which stocks can break free and outperform the cohort. Sector analysis is key here and it requires doing a lot of homework.

“Nothing’s worse than owning a bad stock, as defined by weak earnings, in a bad sector neighborhood. Nothing’s better than owning a good stock in a great neighborhood,” Cramer said. “But if you do not measure the stock’s earnings against the sector’s growth and you do not determine first whether the sector is in favor versus out of favor than the earnings report, better than expected or not, just won’t mean a thing.”

—Read on for Cramer's Top Dividend Stocks

When this story was published, Drew Sandholm owned the Financial Select Sector SPDR ETF.

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