For the past 8 years, our market has been on a bull run which is close to exceeding unprecedented lengths. We are witnessing the 2nd longest and strongest bull market in history, with that being said, it is easy to see why so many people are worried that we may be nearing the end. There are a lot of ways to prepare for the eventuality of bear market, one of the best ways is through dividend investing. If the market does enter a bearish phase or becomes flat, dividend companies will continue to pay dividends. Another benefit of dividend investing is that you can reinvest that dividend during market downturns and buy stocks at lower than usual prices. Even if this bull market keeps going though, dividend investing is still highly profitable as long as you invest in companies that are backed by strong fundamentals.
There is a causal relationship between the strength of the economy and how the stock market performs. The most important quality to look for when dividend investing is strong fundamentals, it is imperative to find a company which is not subjected to any cyclical affects. When the economy enters a downturn, a dividend paying company needs to be able to withstand any macro affects, there are even rare situations where companies actually perform better during recessions. Generally speaking, companies which pay dividends are more stable and healthy then ones which do not. However, dividends are more complicated than people believe, there are several factors to look into when looking for quality high dividend yield companies. While a high dividend yield and consistent dividend growth is important, it is more important to assess the health and sustainability of a dividend. You have to look at the industry the company is in and if it is cyclical or not, companies in cyclical industries tend to have inconsistent dividends. The payout ratio and how much free cash flow a business generates are both equally important metrics to determine the sustainability of a dividend, the net debt to EBITDA ratio should also be taken into consideration.
Even with pressure from the so called "Amazon Effect", Wal-Mart (WMT) shares have climbed nearly ten percent since the start of the year. The most appealing thing about Wal-Mart during a economic downturn is it's everyday low prices. During recessions, Wal-Mart is a very appealing place to shop at due to its low prices and bargain deals. People go to Wal-Mart more because they are trying to save money. The main fear people have when investing in Wal-Mart is Amazon (AMZN), Amazon has seemingly changed the retail landscape entirely. However, Wal-Mart has been able to fend them off, in fact, it seems that Wal-Mart is going on the offensive right now. Wal-Mart's E-commerce sales grew by 63 percent year over year last quarter, they have been heavily investing in E-commerce to try to catch up to Amazon. On the defense side, everything is going well too, last quarter marked the 11th consecutive quarterly rise in same store comparable sales. Wal-Mart fills the needs of the American consumer at a low cost, they are well established and are expanding their presence digitally. With that said, let's take a close look at their dividend.
Wal-Mart pays an annualized dividend of $2.04 that is paid out every quarter, this is a 2.7 percent yield, above the services average of 1.96 percent. For the past 42 consecutive years Wal-Mart has consistently raised their dividend, even during recessions their dividend has been raised. The payout ratio for Wal-Mart's dividend is 46.8 percent suggesting that there is still room for the dividend to be increased and that it is not unsustainable. From a cash flow perspective, it looks very good. Wal-Mart's free cash flow jumped from $12.69 billion to nearly $21 billion in just 4 years (2013-2017). Wal-Mart's total debt to EBITDA ratio is 1.43, with such a low number, it is unlikely Wal-Mart's current debt will compromise their dividend. With the recent news of Amazon buying out Whole Foods (WFM), Wal-Mart shares are down around 5 percent, this is a great opportunity to pick up some shares.
Johnson and Johnson
It is hard to find a more fundamentally sound company then Johnson and Johnson (JNJ). Johnson and Johnson is a pharmaceutical and consumer products company, they are one of the last two companies in the United States with a triple A credit rating. They have several well known household consumer essentials such as Tylenol and Aveeno, they even sell baby lotion under their Johnson brand. With Johnson and Johnson owning over 100 brands and many of those being consumer essentials, it is hard to imagine Johnson and Johnson will ever lose their luster. There is no doubt that this century old company would be able to survive a recession too, by owning consumer essentials such as the band aid, they are effectively recession proof. Their pharmaceuticals and medical devices business segments are recession proof as well, there will never not be demand for healthcare. A recession can not hamper drug or medical devices demand, people will always spend their money on healthcare since it is so essential in our lives. This has allowed Johnson and Johnson to operate and prosper for over a century.
One of the best parts about owning Johnson and Johnson shares being able to get its fantastic dividend. Johnson and Johnson pays out an annualized dividend of $3.36 that is distributed evenly every quarter. This is a 2.52 percent yield, well above the healthcare average of 0.77 percent. Johnson and Johnson has consistently hiked their dividend every year for the past 54 consecutive years too. With a payout ratio of 47.3 percent, it is safe to say there is room for more hikes down the road too. Johnson and Johnson also strong earnings growth and an increasing free cash flow. Net income from 2012-2016 nearly jumped 50 percent from $10.51 billion to $16.54 billion. Free cash flow increased from $12.46 billion to $15.54 billion from 2012-2016, Johnson and Johnson also has a low total debt to EBITDA ratio of 1.08. As long as cash flow and earnings continue to increase like they have been, there is no question that Johnson and Johnson will continue to increase their dividend.
With great fundamentals and a recession proof business model, McDonald's (MCD) seems like a solid choice. McDonald's is the world's largest fast food chain with a large domestic and international presence. Not only does McDonald's generate strong earnings and revenue growth during economic boons, but their business model is resistant to weakening economic conditions. By selling their food at low prices and marketing their food as affordable, McDonald's becomes the first option that comes to mind when wanting to save money on food. When consumers are looking to save money during an economic downturn, they will go to McDonald's to get affordable food on demand. Their low cost menu helps fill the demand for affordable food during recessions, this business model helps McDonald's flourish when recessions occur.
With an annualized dividend of $3.76 that is paid quarterly, McDonald's dividend yield comes out to be 2.45 percent. This exceptional dividend has also been hiked every year consistently for the past 40 years. Although the payout ratio is 58.8 percent, there is still room for dividend hikes in the future as long as earnings continue to grow. With free operating cash flow more than doubling since 2007 and a total debt to EBITDA ratio of 2.7, there is no doubt that neither weak cash flows or debt will jeopardize McDonald's dividend.
Whether you are a dividend investor or not, all of these companies are still fundamentally solid. I believe that it's worthwhile to own at least one of these stocks in your portfolio to hedge against any potential economic downturns. Personally, I doubt there will be an economic recession any time soon or any major correction to the stock market, but that is a topic for another day. However, that is not me trying to say it is not worthwhile to hedge, hedging is the best way to protect your gains from this 8 year bull market. There is no real way to predict the future state of the economy, only ways to prepare. One of the best ways to prepare is to invest in high yield dividend companies which perform well during economic downturns. Not only does it give you a steady stream of passive of income, but it also gives you a chance to reinvest any profits and buy cheaply valued stocks during bear markets. You can never be too prepared.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.