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This program last aired on Oct. 19. NEW YORK ( TheStreet) -- Jim Cramer opened his investing toolbox to help make his "Mad Money" viewers become better investors. He said a good investor knows to expect the unexpected, which is why diversification is still the only way to invest. Cramer start off with a lesson in humility -- he admitted that sometimes he gets it wrong. Sometimes his stock picks just simply don't work out. That's investing. Any investor putting together an investing portfolio needs to be prepared, said Cramer, because sooner or later something won't work out. But how should investors prepare for the next market catastrophe or stock pick gone bad? Cramer said not by being bearish, but by being smart. Being a bear, he continued, means shorting stocks hoping they go down. While that's a valid investing strategy, it limits one's profit potential since the lowest a stock can go is zero. But compare that to bullish investing, betting that stocks go higher. Their potential profits are limitless, he said. Investors who invested in Apple ( AAPL) in 2009, for example, realized a 580% gain over the next three years. Beyond having a positive outlook, Cramer said the most important rule to managing your money is diversification. He said that means not having all your eggs in one sector basket. A portfolio with five stocks must have only one technology company, one health-care name, one energy company, one industrial, etc. Two or three of a kind is a quick way to get caught off guard, so no more than 20% of a portfolio can be in a single sector. Being diversified is more than just investing in different sectors, however. Cramer said the new rules of diversification also require owning some gold in your portfolio, along with a high-yielding dividend stock, as well as a growth stock, a speculative stock and one that's firmly rooted in a healthy geography.
Check the DividendsCramer said the most important category of stocks that must be in a diversified portfolio is a high-yielding dividend stock. He said that every portfolio needs at least one, possibly more, dividend payers.
While dividend stocks might not seem sexy, Cramer said that, put simply, dividends make money. In fact, nearly 40% of the total gains from the S&P 500 since 1926 have come in the form of dividends. Over the past decade, that percentage is even higher. Dividends aren't merely safety plays for retirees and cautious investors, said Cramer. They are a smart strategy for making money. He explained that as a stock price falls, its dividend yield increases, which in turn makes in more attractive to investors. Stocks that hit a 4% yield represent terrific long-term bargains, he noted, which is why stocks typically stop going down once they hit 4%. But beyond making money, Cramer said dividends, and especially dividend raises, are management's way of telling investors that things are going well at the company. A solid, steady dividend that gets raised regularly is a hallmark of a company that's stable and doing sell. Not all dividends are created equal, however, cautioned Cramer. Dividend yields that are not sustainable are red flags. Just look at what happened to Radio Shack ( RSH) and supermarket SuperValu ( SVU) in early 2012 for a lesson in dividends gone awry. A company's earnings per share should be at least twice that of its dividend payout to be considered safe. For companies with high capital needs, like telecoms, he said investors can look at the cash flow as another metric to see whether the dividend may be in jeopardy.
Looking for GrowthNext up in Cramer's toolbox of investing tips, growth stocks. Stocks like Apple, Whole Foods ( WFM) and Amazon.com ( AMZN) all fit this category, said Cramer, as do many biotech names like Amgen ( AMGN) and Celgene ( CELG). Growth stocks will hit new high after new high as long as their growth continues. That's because stock prices represent what investors are willing to pay for future earnings. So as a company's earnings grow, so does its share price. Cramer said that as a rule he's willing to pay up to two times a company's growth rate. So for a company growing 20% a year, he's willing to pay up to 40 times their earnings. Growth stocks typically won't trade below one time their growth rate unless something is going wrong.
Cramer told investors to pay close attention to the direction of the earnings estimates anytime they're investing in growth names. When earnings have momentum, companies can see their stock double in just a year, but if the earnings begin to slow, they will fall sharply, as Chipotle Mexican Grill ( CMG) saw in July when shares tumbled 100 points on the mere suggestion the company may be vulnerable to a weakening U.S. economy.
Speculative ThinkingEvery portfolio also needs something to keep you interested, said Cramer, and that means at least one speculative stock. While speculation has become a dirty word on Wall Street, something most financial advisers will tell you to avoid, Cramer said it's important to stay engaged with your stocks and to continue to do your homework, otherwise investing will become no more profitable than gambling. To speculate wisely, Cramer said investors need to use the right rules and maintain their discipline. Speculation can provide investors with enormous gains, he said, but if done incorrectly can yield gut-wrenching losses. When it comes to speculating, most investors look towards stocks under $10 a share. Cramer said there are two kinds of stocks in this category: those with broken companies and those with merely broken stocks that have been left for dead by money mangers that aren't allowed to invest in things under $5 a shares. Investors can take great advantage of the latter, said Cramer. Two great examples of "left for dead" stocks include Ford Motor ( F) and Sallie Mae ( SLM) back in 2009. During the height of the great recession, both companies were hated by Wall Street, sending shares into the single digits. But beneath all of the skepticism they were solid companies, said Cramer, which is why Sallie Mae was his speculative stock of the year in 2009, when the company's $6 a share stock rose to over $16. In today's market, Cramer said he's a fan of Sprint Nextel ( S), a stock that had fallen to just $2 a share on bankruptcy rumors, but since then has more than doubled and isn't done going higher.
More often than not, however, stocks under $10 a share are tiny names that you've probably never heard of. These may be fads or companies that are mere shells of their former selves. But that doesn't mean there aren't diamonds in the rough out there if you know where to look.