This has been an incredible year for the stock market. Through this past weekend, all three major U.S. indexes had gained between 16% and 24% year to date, which trounces historic annual returns for the market of around 7%, inclusive of dividends and when adjusted for inflation. This jibes with the fact that the current economic expansion is the longest on record for the United States, dating back to when record keeping began, about 160 years ago.
But as investors, we also know that peaks and troughs in the economic cycle are inevitable. With the bull market now lasting in excess of 10 years, it's only logical to expect an economic contraction, or even recession, to strike sooner rather than later. And when one does, dividend stocks will have an opportunity to show their true value.
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High-quality dividend stocks will prove their worth when the next recession strikes
You see, companies that pay a dividend are often profitable, have time-tested business models, and help investors to keep a level head. A business is unlikely to keep sharing a percentage of its profits with investors if its board doesn't foresee continued growth and/or profitability.
Furthermore, payouts can be reinvested back into shares of more dividend-paying stock via a dividend reinvestment plan (DRIP) to really accelerate wealth creation. In doing so, investors acquire a greater number of shares of dividend-paying stock, receive a larger payout, and then are able to use that bigger payout to buy even more shares of stock. DRIPs are an especially popular and powerful tool for Wall Street's most successful money managers.
Of course, not all dividend stocks are created alike, and some will definitely feel the pain when a recession strikes. But the following three high-yield dividend stocks (greater than 4% yield) wouldn't even bat an eye if a recession were to strike tomorrow.
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AT&T
If there's one thing we've learned as investors, it's that subscription-based services are extremely hard for consumers to give up. While the cord-cutting associated with cable might be one of the few exceptions to the rule, telecom and content giant AT&T (T +0.86%) has little to worry about when the next recession hits.
A significant portion of AT&T's profitability is driven by its high-margin wireless division. Though wireless saturation rates are high in the U.S., AT&T and its peers are beginning the rollout of 5G networks. This represents the first major upgrade to wireless infrastructure in nearly a decade, and it's likely to lead to one of the strongest tech upgrade cycles we've ever seen. With the ability to download movies in a matter of seconds, 5G could usher in a new wave of data-driven profits for AT&T. Even though it's early, AT&T has a 5G presence in more cities than all of its major competitors, combined.
Despite the cord-cutting associated with traditional cable, AT&T intends to combat this weakness with its streaming services. This is a good time to mention that the acquisition of Time Warner adds the CNN, TNT, and TBS lineup to its portfolio, giving the company more sway to lure streaming consumers, as well as extra pricing power when negotiating with advertisers.
Ultimately, AT&T is a boring company -- and that's great news for investors during a recession. With the company's below-average volatility and relatively predictable cash flow, its 5.5% yield is the stuff that dreams are made of for income investors.
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Innovative Industrial Properties
No, your eyes aren't deceiving, and yes, cannabis real estate investment trusts (REITs) do actually exist.
Innovative Industrial Properties (IIPR 2.19%) was the very first pure-play marijuana stock to find its way to a major U.S. exchange, and is today the only pot stock that pays a dividend. With a 4.4% yield, it also happens to be a high-yield stock, although that shouldn't be too surprising, given that REITs pay out most of their profits in the form of a dividend to avoid normal corporate income tax rates.
Although the U.S. pot industry has had its fair share of growing pains, Innovative Industrial Properties has found itself practically immune to these concerns. The reason there's little concern -- and to boot why there would be no worries if a recession struck -- is that IIP's business model is based on collecting predictable rental income over very long periods of time. In other words, predictability and profitability practically guarantee smooth sailing.
After beginning the year with 11 properties, IIP now owns 35 grow farms and processing sites in 13 states. These rental assets have a weighted-average remaining lease term of 15.6 years, and a current yield on its $371.6 million in invested capital of 13.8%. This means Innovative Industrial Properties will recoup its investments in just over five years, but has another decade beyond that where steady cash flow will be coming in. Not to mention, IIP also passes along a 3.25% rental increase per year to its tenants, ensuring that it stays ahead of the inflationary curve. No short-term recession is going to alter these rock-solid returns.
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Philip Morris International
A third high-yield stock that could care less if the U.S. dipped into a recession is tobacco giant Philip Morris International (PM +0.65%). At a yield of 5.8%, Philip Morris offers the highest income-based return of these three high-yield dividend stocks.
Though tobacco usage has fallen among adults in a number of developed markets, including the United States, this isn't a huge concern for Philip Morris. That's because it doesn't sell tobacco cigarettes in the U.S., but it does sell them in more than 180 other countries around the world. Weakness in developed markets can be met with burgeoning middle classes looking for affordable luxuries, such as tobacco, in emerging-market economies. Thus, geographic breadth is one saving grace for Philip Morris.
Secondly, this is a company that benefits from selling a vice product. Tobacco contains nicotine, a highly addictive chemical that keeps consumers coming back for more. By effectively building up its brands -- especially its premium Marlboro brand in overseas markets -- Philip Morris has been able to grow its sales through price hikes, even as cigarette shipping volumes have fallen.
Philip Morris also has its eyes on tobacco alternatives. The company's IQOS heated tobacco device has seen its total user count grow from an estimated 7.6 million in the first quarter of 2018 to 12.4 million in the third quarter of 2019. This user growth is a big reason behind the 45.7% year-over-year increase in heated tobacco unit shipping volumes through the first nine months of 2019.
Between its strong pricing power and growing revenue stream beyond traditional tobacco cigarettes, Philip Morris would have little to worry about if a U.S. recession struck.
