Let's get the unpleasant news out of the way: A stock market crash may be brewing.
In a three-week stretch, growth stocks have been pulverized by rising Treasury yields and valuation concerns. The higher Treasury bond yields rise, the more likely it becomes that investors will choose the safety of bonds yields over the riskier stock market.
However, every single stock market correction and crash in history have proved to be a buying opportunity for long-term investors. The question is: "What to buy if a market crash does take shape?"
Perhaps the best answer to that query is dividend stocks. Companies that pay and grow their dividend have historically run circles around non-dividend-paying stocks over the long run. Further, stocks that pay a dividend are often profitable and have time-tested business models. Although investors still need to exercise caution when selecting dividend stocks, buying them during a market crash can set portfolios up for success.
If a stock market crash does arise, these are the four best dividend stocks to buy.
Johnson & Johnson: 2.6% yield
Healthcare stocks aren't well-known for their dividends. Even though healthcare is a highly defensive sector -- i.e., we don't get to choose when we get sick or what ailment(s) we develop -- reinvestment into drug and device development eats up a lot of cash flow. But that's not a concern for healthcare conglomerate Johnson & Johnson (JNJ 0.91%), which is likely to announce its 59th consecutive annual dividend hike next month.
The beauty of the Johnson & Johnson operating model is that every puzzle piece has a purpose. The company's consumer healthcare division is its slowest-growing, but it provides the most predictable cash flow and modest pricing power. Then there's the medical-device segment, which has been hit in the near-term by competitive pressures, but offers significant long-tail growth as an aging population becomes more reliant on drugs and devices to maintain good quality of life. Finally, pharmaceuticals have a finite period of exclusivity, but are currently providing the bulk of J&J's margins and pricing power.
If capital preservation is of the utmost concern during a stock market crash, Johnson & Johnson has you covered here, too. There are only two publicly traded companies that bear the AAA credit rating from Standard & Poor's, and J&J is one of them. With a higher credit rating than the U.S. government, S&P has more faith that J&J will make good on its debts than the U.S. government.
Annaly Capital Management: 10.6% yield
Ideally, income seekers want the highest yield possible with the least risk imaginable. In the real world, risk and yields tend to be correlated. Thankfully, dividend investors can buy into the ultra-high-yield Annaly Capital Management (NLY 2.15%) with confidence.
Annaly is a mortgage real estate investment trust (REIT). That's a fancy way of saying that Annaly buys assets that generate a long-term yield, such as mortgage-backed securities (MBS), and it borrows money at lower short-term rates to lever up when buying these assets. The difference between the yield it receives from its MBSs and its borrowing rate is known as its net interest margin (NIM). When the yield curve steepens during the first couple of years of an economic recovery, the NIM for mortgage REITs expands.
Something else about Annaly Capital Management that'll calm nerves is its asset mix. The company almost exclusively buys agency-backed MBSs and securities. This means they're backed by the federal government in the event of default. As you might imagine, this added protection means lower yields for agency assets compared to non-agency securities. However, the protection allocated to agency assets allows Annaly to use leverage to its advantage. This is why its 10%-plus yield looks safe for years to come.
AT&T: 7.2% yield
Another top-tier dividend stock that can be safely bought by income seekers during a market crash is telecom giant AT&T (T -0.14%). Though AT&T is lugging around quite a bit of debt, a recent deal to sell a minority stake in DirecTV, coupled with other cost-cutting and non-core asset sales, will help lower its debt and lock in its 7%-plus dividend yield as safe.
There's no denying that AT&T's best growth days are in the rearview mirror. Still, it should receive a healthy shot in the arm of organic growth thanks to ongoing wireless infrastructure upgrades. It's been a decade since wireless download speeds were last upgraded. With AT&T shifting its focus to 5G, you can bet that enterprise and retail customers will be clamoring to upgrade their devices over the coming years. Since data is the high-margin driver of AT&T's wireless segment, a steady uptick in cash flow should be expected.
AT&T is also stomping on the gas pedal when it comes to streaming services. Despite a tempered launch from HBO Max in late May 2020, subscribership has picked up in a big way in recent months. In particular, subsidiary WarnerMedia is planning to release its newest films on HBO Max in 2021 the same day they're slated to hit movie theaters. That could be a dangling carrot that millions of streamers won't be able to ignore.
Broadcom: 3.2% yield
Finally, tech stock Broadcom (AVGO) is one of the best dividend stocks investors can buy during a market crash. Don't let its 3.2% yield fool you: This is a company that's increased its quarterly payout by over 5,000% in a decade!
As some of you may already know, Broadcom is a semiconductor solutions company that generates a significant portion of its income from smartphones. The 5G boom is going to be big news for Broadcom, which supplies wireless chips and other accessories used in smartphones. Since this upgrade cycle will last years, Broadcom's solutions should lead to consistent mid-to-high single digit annual sales growth. According to reports, customers have already ordered 90% of Broadcom's chip supply for 2021.
Broadcom is also a key player in data centers. Before COVID-19, we were witnessing businesses big and small pushing online and into the cloud. The pandemic has simply taken this existing shift and expedited it. That's only going to increase demand for Broadcom's connectivity and access chips.
Any dip in Broadcom during a market correction or crash is an opportunity for income investors to do some shopping.