We're not officially in a recession yet, but some have predicted that the current trajectory of the economy will land us squarely into recession territory relatively soon. An economic downturn would bring many problems to most people's doorsteps. And as a result, investing in stocks may not remain a priority for many, and even if it does, investors will be substantially more careful about where they put their money.
With that in mind, let's look at one category of stocks that generally is particularly well-equipped to handle recessions: dividend stocks. Here are two reasons why strong, dividend-paying companies are worth looking into if a recession hits.
1. Solid businesses
Plenty of companies reward their shareholders with regular dividend payments. But dividend stocks aren't all created equal. Consider that in 2020, global dividend payouts decreased by 12.2% due to the pandemic-induced recession. One company in eight canceled its dividend, one in five reduced it, but two companies in three increased their payouts or left them untouched.
Excellent, dividend-paying companies -- those that maintain or raise their payouts even during challenging economic times -- tend to have robust businesses. They often boast solid balance sheets and continue generating decent profits and cash flows regardless of economic conditions. The factors that allow top dividend stocks to maintain their payouts also help them navigate recessions better than most.
When consumers reduce their spending, financially stable corporations can still meet their short-term obligations -- and continue paying dividends at the same time. That's a recipe for success amid an economic downturn.
2. Dividends can help smooth out market losses
Market downturns often, but not always, accompany recessions. The S&P 500 is currently in a bear market (defined as a 20% or more drop from its most recent high), but it could potentially recover before a recession officially hits. If it doesn't, those who invest in solid dividend stocks will arguably be better off.
After all, dividends are part of the total return equation for stock market investors. According to some estimates, 84% of the total return of the S&P 500 between 1960 and 2021 is the result of reinvested dividends and the magic of compounding. When equities fall, consistent dividend payments help negate losses from the decline in prices of stocks.
Naturally, dividends can also be a great source of passive income when hard times hit. With these perks in mind, let's consider an excellent dividend stock to consider buying to prepare for a recession.
You can take this dividend to the bank
The healthcare sector is a good place to look for dividend stocks since customers still need medical services even during the worst recession. And one of the most notable, dividend-paying companies in this sector is pharma giant Johnson & Johnson (JNJ -0.63%). This drugmaker is a Dividend King -- it has raised its payouts for a whopping 59 consecutive years.
In the past three years, a period that includes the coronavirus pandemic and its harmful effects on the economy, J&J increased its dividends by 19%. The company's yield of 2.42% is well above the S&P 500 average of 1.37%, and its cash payout ratio of 57% is reasonable. Johnson & Johnson's business is solid, with plenty of medicines that generate more than $1 billion per year and a rich pipeline that boasts dozens of ongoing clinical trials.
Johnson & Johnson is well-positioned to routinely earn new regulatory approvals, thereby expanding its revenue base. The company has a Standard & Poor's credit rating of AAA, the highest possible and a testament to its robust balance sheet and ability to handle its debt.
Johnson & Johnson will spin off its consumer health segment by the end of the year, which should lead to more robust top-line growth and decrease its exposure to lawsuits associated with some of its products in this segment. While the transaction will decrease the diversity of its operations, in my view, it will strengthen the company.
Overall, Johnson & Johnson is an excellent stock for dividend investors and those looking for stable blue chip companies amid economic problems and heightened stock market volatility.