There are few things that get the attention of new and tenured investors quite like the "R" word: recession.
Roughly two weeks ago, the minutes from the Federal Open Market Committee's March meeting revealed that the staff is now modeling a "mild recession" for later this year. While numerous leading economic indicators and recession-probability tools have suggested a U.S. recession was growing likely, this is the first time we've seen the Fed admit that economic weakness is now built into its outlook.
Although the U.S. economy and stock market aren't linked at the hip, 95 years of history show that around two-thirds of the stock market's drawdowns typically occur after, not before, a recession is declared. It suggests the stock market might not have seen its bear market lows just yet.
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But this doesn't mean investors should head for the sideline. On the contrary, bear markets have represented surefire buying opportunities for as far back as you can see. Every single crash, bear market, and correction throughout history -- save for the current bear market -- has eventually been recouped (and then some) by a bull market.
If you want to further improve your chances of making money during a recession, consider buying dividend stocks. Companies that pay a regular dividend are often time-tested, profitable on a recurring basis, and offer transparent long-term outlooks. They're just the type of businesses that can make patient investors richer if volatility and uncertainty pick up.
If a recession does take shape, the following three ultra-high-yield dividend stocks (a term I use to describe income stocks with yields of 7% or above) have the necessary catalysts to make you richer.
Enterprise Products Partners: 7.31% yield
The first supercharged income stock that can pad your pocketbook and help grow your portfolio, even if a recession occurs, is energy stock Enterprise Products Partners (EPD 0.07%). Enterprise has raised its base annual distribution for the past 24 years and is currently yielding an inflation-topping 7.3%.
Some of you might be scratching your head as to why an energy stock would be on this list. Normally, energy commodities such as oil, natural gas, and coal struggle during recessions, which typically weighs on energy stocks. But Enterprise Products Partners is a different breed of energy stock that's well protected from the volatility that's inherent in the sector.
Enterprise is one of the nation's largest midstream companies, which are effectively middlemen tasked with transporting, storing, and processing oil, natural gas, natural gas liquids (NGL), and refined products. Enterprise owns more than 50,000 miles of transmission pipelines and can store in excess of 260 million barrels of liquids (oil, NGL, and refined products).
What protects the company from the wild swings that can occur in commodity spot prices are its contracts. The majority of Enterprise Products Partners' contracts with drillers are fixed-fee deals.
Fixed-fee contracts eliminate inflation from the equation and ensure predictable operating cash flow no matter what happens with the spot price of crude oil and natural gas in the short term. Having cash-flow transparency is particularly important since it allows Enterprise to outlay capital for new infrastructure projects, acquisitions, and its distribution, without the fear of hurting its profits.
Another reason investors can trust Enterprise Products Partners during a recession is the unique situation the global energy complex finds itself in. In addition to Russia invading Ukraine last year and throwing a monkey wrench into Europe's energy needs, global energy majors have underinvested for the past three years due to the pandemic. While a recession would normally create a supply glut that depresses the price of crude oil, pervasive supply constraints could provide more of a lift than in prior recessions.
PennantPark Floating Rate Capital: 11.16% yield
A second ultra-high-yield dividend stock that can make you richer if a U.S. recession materializes is business development company (BDC) PennantPark Floating Rate Capital (PFLT 0.35%). PennantPark pays its dividend monthly and is currently yielding a hearty 11.2%.
BDCs invest in middle-market companies. What this means in plain English is that BDCs either buy common/preferred stock or debt in small-cap companies. As of the end of 2022, PennantPark's portfolio was worth $1.15 billion and primarily consisted of $998.3 million in debt investments. While there can be advantages to owning common and preferred stock, holding a debt-focused portfolio should be especially lucrative for PennantPark in the quarters to come.
One of the core advantages of dealing with middle-market companies is that they're usually unproven, and as a result, their access to credit and debt markets is limited. This allows BDCs like PennantPark to net above-average yields on the debt/financing they own or undertake.
To build on this point, every cent of the company's $998.3 million debt investment portfolio is variable rate. With the nation's central bank raising interest rates at the fastest pace in more than four decades to tame historically high inflation, every single debt investment held by the company has seen its yield rise.
Between Sept. 30, 2021, and Dec. 31, 2022, PennantPark's weighted average yield on debt investments jumped 390 basis points to 11.3%. Note: This figure doesn't account for rate hikes that have taken place since 2023 began.
What's more, PennantPark has spread out its investments to ensure that no one company can sink the ship. Including its equity investments, the company's $1.15 billion portfolio is spread across 126 companies, which works out to an average investment of $9.1 million.
Furthermore, $998.2 million of its $998.3 million debt investment portfolio is first-lien secured debt. First-lien secured debtholders are first in line to be paid in the event that a company were to file for bankruptcy protection. This small-cap BDC has all of its bases covered.
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Innovative Industrial Properties: 10.42% yield
The third ultra-high-yield dividend stock that can help make you richer if a recession occurs is none other than cannabis-focused real estate investment trust (REIT) Innovative Industrial Properties (IIPR 0.72%), which is commonly known as IIP. Since quarterly distributions began in 2017, IIP's payout has grown by 1,100%.
The big advantage that REITs typically offer is the predictability of their operating cash flow. These are businesses that acquire properties within a specific sector or industry and seek to lease these assets for extended periods. The end result tends to be transparent long-term cash flow and a dividend that handily outpaces the prevailing rate of inflation.
However, Innovative Industrial Properties has hit a bit of a snag in recent months as rent delinquencies have risen. In February, it collected 92% of its rents on time.
While this isn't ideal, all REITs eventually contend with delinquencies. Based on the company's February update, it's taking the appropriate steps to either divest itself of these properties, transfer the leases to other multi-state operators (MSOs), or amend the existing master-lease agreements. In other words, IIP's significant share-price discount in the wake of this delinquency data looks like a massive buying opportunity.
Another catalyst that helps to secure IIP's ongoing profits is its lease structure. The entirety of the company's portfolio (more than 100 properties) is triple-net leased. A triple-net lease requires the tenant to effectively cover all property costs, such as utilities, maintenance, property taxes, and insurance. While these added costs do lower the rental income IIP receives, it also absolves IIP of any unexpected expenses.
Innovative Industrial Properties isn't hampered by the lack of progress on cannabis reform in Washington, D.C., either. In fact, it's actually benefiting from the stalemate.
As long as cannabis remains illegal at the federal level, MSOs will have minimal access to basic financial services. IIP is stepping up to the plate by purchasing assets with cash and immediately leasing these properties back to the seller. These sale-leaseback agreements put much-needed cash into the hands of MSOs while netting IIP long-term tenants.
Lastly, consider that marijuana is a nondiscretionary good. No matter how poorly the economy performs, consumers continue to purchase pot products. With cannabis expected to be one of the fastest-growing industries in the U.S. this decade, it bodes well for an established cannabis REIT like Innovative Industrial Properties.
