Cramer's 'Mad Money' Recap: Best Use of Earnings News (Final)

This show originally aired on January 19, 2012

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NEW YORK ( TheStreet) -- "I want to show you a new way to use earnings season," Jim Cramer told his "Mad Money" TV show viewers, as he dedicated his entire show to helping individual investors navigate the overwhelming nature of the busiest time on "Wall Street."

Cramer explained that it's important to put earnings and their accompanying conference calls into context, as earnings alone can't be relied on to predict a stock's future behavior as it once was. In today's complex markets, Cramer said that earnings are only one piece of the puzzle that determines where a stock is headed after it reports.

According to Cramer, earnings seasons are a great time for investors to re-evaluate their portfolios and decided which stocks they should trim and which they need to buy more of. He said that earnings should allow investors to "hone their thinking" on which stocks are performing and which ones aren't.

Cramer said that when he looks at a company's earnings, he first looks at the predictive value of those earnings. Did the company beat even the highest analyst estimates? If so, those analysts are likely to be raising their estimates soon. Did the company produce a genuine beat with higher revenues? If so, then the company is on track. But if the earnings came from trick accounting, like buying back stock, favorable tax rates or aggressive cost-cutting, then those earnings may not last.

Cramer told investors not to rely on just a company's price earnings, or p/e, ratio as a measure of whether a stock is cheap or expensive. He said investors must always factor in growth by using the PEG ratio, which is a company's multiple divided by its growth rate. Cramer said he's willing to pay up to twice the PEG ratio for a company that's growing. Those with PEG ratios below one are super-cheap, assuming there aren't any underlying issues.

Sector Holds Key

Cramer said his next step toward evaluating a company's earnings is to look at its sector. He explained that in the old days, a company's sector could account for 50% of its performance. But in today's markets that are riddled with ETFs that lump similar stocks together, a company's sector is more important than ever.

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