The Best Stocks for a Down Market

If you're a realist, you know that bad things happen. It's true in life; it's true in investing. Every now and then, we have to endure a down market.

Fortunately, you don't have to just let a bear market happen to you, taking your lumps along the way. There are ways to not just prepare for it ... but profit from it.

The virtue that's really a virtue
When stocks start falling, stay patient. Those who do the worst in investing sell impulsively when the chips are down out of fear or ignorance.

Instead, take your time to assess the situation. You may find some bargain stocks to buy. As Warren Buffett has long advised, it pays to be fearful when others are greedy, and greedy when others are fearful.

De-fense! (clap, clap) De-fense! (clap, clap)
One way to position yourself for a bear market is to sell your stocks now and invest in something that will be better at protecting your capital, such as a savings account or CD.

Of course, if the next bear market doesn't happen for five years, you'll probably be giving up considerable gains in the stock market, while your "safe" investments will likely barely beat inflation.  

Instead, consider investing in defensive companies -- ones in industries that are not as affected by market downturns as others. That list includes pharmaceuticals, consumer staples in the food and drink category, utilities, and tobacco. If you take Claritin for allergies, for example, you're not going to stop if the economy slows. Similarly, if you're feeling pain in your wallet, you'll still use underwear and baby wipes -- although you may try to buy fewer of them. And chalupas, while somewhat of a luxury, will still sell more than an expensive luxury like filet mignon.

In other words, Schering-Plough (NYSE:SGP), Playtex Products (NYSE:PYX), and Yum! Brands (NYSE:YUM) are defensive companies.

Make money one way ... or the other
Another sensible approach is to seek out significant dividend-payers among stocks. That's because, when it comes to stocks, there are two payoffs:

1. Stock price appreciation.
2. Dividend payouts.

During a down market, you can say sayonara to stock price appreciation for at least a little while. But that won't be so bad if you've invested in some strong dividend-payers: You'll collect fat payments no matter how the market behaves.

Four ideas for you
With the S&P 500 still near highs despite the recent drop, I've been shifting many of my individual stock holdings over to dividend-payers in preparation for a longer downturn myself. If you're looking to do the same, here are a few more companies that sport healthy dividend yields and are also defensive plays, to at least a significant degree:

Should you snap up shares of these companies? Not necessarily -- at least not without doing additional due diligence. For example, is the valuation reasonable?

If you'd like to learn more about some great dividend-paying stocks, I invite you to check out our Motley Fool Income Investor service free for 30 days. Advisor James Early's picks are beating this up market by more than six percentage points, and their average yield of more than 4% will help you position your portfolio well for the next down market. Click here to learn more.

This article was originally published on June 22, 2007. It has been updated. 

Longtime Fool contributor Selena Maranjian owns shares of Yum! Brands. She was surprised to learn recently that in Switzerland, apparently almost everyone has the same kind of mailbox. National Grid is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.