The Best Stocks for a Down Market

If you're a realist, you know that bad things happen. It's true in life; 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. Those who do the worst in investing 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 and invest in something that will be better at 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 -- ones in industries that are not as affected by economic downturns as others. That list includes pharmaceuticals, consumer staples in the food and drink category, utilities, and tobacco. If you take medicine for arthritis, for example, you're not going to stop patronizing your local pharmacy if the economy slows. Similarly, if you're feeling pain in your wallet, you'll still buy underwear and scarves if you need them -- though perhaps you'll seek out low prices for them.

In other words, Wyeth (NYSE:WYE), Kohl's (NYSE:KSS), and Walgreen (NYSE:WAG) are more "defensive" companies.

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 strong dividend payers; you'll collect fat payments no matter how the market behaves.

Three ideas for you
With the S&P 500 still near its highs despite a recent drop, I've been shifting many of my own individual stock holdings over to dividend payers. If you're looking to do the same, here are a few more companies that sport healthy dividend yields and are also defensive plays, at least to a significant degree:

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 this up market by more than five percentage points, and their average yield of more than 4% will help you position your portfolio well for the next down market. 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 PepsiCo. Diageo is an Income Investor recommendation. The Motley Fool is  Fools writing for Fools.