The Best Stocks for a Down Market

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If you're a realist, you know that bad things happen. It's true in life, and 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. The worst-performing investors 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, investing instead in something better-suited for 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 -- those in industries 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 Fosamax for osteoporosis, 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 -- though perhaps you'll try to buy them at discount retailers more often. And Frosties, while somewhat of a luxury, will still sell more than an expensive luxury like filet mignon.

In other words, Merck (NYSE: MRK), Wal-Mart, and Wendy's (NYSE: WEN) are defensive companies. Car makers and cruise companies are far less defensive, since you can usually put off buying a new car or going away on vacation.

Make money one way ... or the other
Another sensible approach is to seek out significant dividend payers among stocks. Stocks offer 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 healthy dividend payers; you'll collect fat payments no matter how the market behaves.

Four ideas for you
Given the S&P 500's recent volatility, I'm glad that over recent years, I've shifted some of my own individual stock holdings toward dividend payers. If you're looking to do the same, here are a few more companies that sport healthy dividend yields and also serve as defensive plays, at least to a significant degree:

Company	Recent Dividend Yield	Defensive Industry
Kraft (NYSE: KFT)	3.4%	Food
Sanofi-Aventis SA (NYSE: SNY)	2.6%	Pharmaceuticals
Southern (NYSE: SO)	4.4%	Electricity
AT&T (NYSE: T)	4.1%	Telecommunications

Source: DividendInvestor.com.

Should you snap up shares of these companies? Not necessarily -- at least, not without doing additional due diligence. For example, is each stock's valuation reasonable? Does it have strong growth prospects and a competitive edge?

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. Advisors James Early and Andy Cross' picks are beating the market by nearly seven percentage points, and their average yield of more than 5% will help you position your portfolio well for the next down market. Last time I checked, I found more than 20 recommendations sporting dividend yields above 6%. 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 Wal-Mart. Southern is a Motley Fool Income Investor recommendation. Wal-Mart is a Motley Fool Inside Value recommendation. The Motley Fool is Fools writing for Fools.