Dividend Stocks That Will Perform Well During a Recession

The past year has been brutal for dividend-focused investors. Companies that not long ago were considered bastions of dividend fortitude -- Bank of America (NYSE: BAC), Fannie Mae, etc. -- are slashing payouts left and right.

There's plenty of reason to be sore about those dividend cuts: Mind-blowingly thorough research from Wharton professor Jeremy Siegel shows that dividends are a crucial driver of long-term market outperformance.

But rather than spend the rest of this recession hiding under a rock, we dividend-loving investors can profit. Yes, many companies are cutting their dividends, but there are plenty of stocks not only maintaining their dividends, but growing them -- 82 in January alone!

Spotting the long-haul winners
As we’ve seen, cuts happen. But fortunately, identifying dividend payers with sustainable, growing payouts isn't exactly rocket science -- you just need to know what you're looking for.

Companies with long, uninterrupted histories of dishing out dividends typically share these three traits.

1. They rake in cash.
Healthy dividends are funded with free cash flow, which means that prodigious cash generation and dividend safety go hand in hand. Dividend aristocrat Automatic Data Processing, for example, converts around 19% of its revenue into free cash.

2. They aren't cyclical.
During boom times, profits in a cyclical industry flow like a Saudi oil well, often leading management teams to overcommit to high dividends and significant expansion (picture major miners Freeport-McMoRan (NYSE: FCX) and Rio Tinto (NYSE: RTP), or shipping giant DryShips (Nasdaq: DRYS). When a cyclical industry tightens up (and such industries always do), cash profits follow suit, and once-high dividend payouts quickly find themselves on the chopping block.

3. They are conservatively capitalized.
Even well-run companies that aren't in cyclical industries can occasionally find themselves on the outs. Look for companies that consistently produce operating profits well in excess of their debt obligations.
t's possible to generate market-beating gains with reliable, well-known companies, the kind of stocks you might actually buy, companies that won't give you an ulcer. Let's go to Siegel's numbers. These are the top 10 "survivor" stocks of the original S&P 500, from inception until post-2000, as ranked by their average annual returns.

4. They do well during bad times. It is very important that you pick dividend companies that have a history of good performance during recessionary periods. Industries like Tobacco, Health Care, Pharmaceuticals, and Soft Drinks all do very well during downturns.

5. You buy them cheap. The following list of companies are selling at or near their 52 week lows. Furthermore, they lead the market for blue-chip companies in terms of highest consistent dividend payout and dividend growth.

Altria
Annual Return 19.8%
Average P/E 13.1
Dividend 8.3%

Abbott Laboratories
Annual Return 16.5%
Average P/E 21.4
Dividend 2.7%

Bristol-Myers Squibb
Annual Return 16.4%
Average P/E 23.5
Dividend 6.1%

Tootsie Roll Industries (NYSE: TR)
Annual Return 16.1%
Average P/E 16.8
Dividend 1.5%

Pfizer (NYSE: PFE)
Annual Return 16.0%
Average P/E 26.2
Dividend 9.3%

Coca-Cola
Annual Return 16.0%
Average P/E 27.4
Dividend 2.2%

Merck
Annual Return 16.0%
Average P/E 25.3
Dividend 5.4%

PepsiCo (NYSE: PEP)
Annual Return 15.5%
Average P/E 20.4
Dividend 3.3%

Colgate-Palmolive
Annual Return 15.2%
Average P/E 21.6
Dividend 2.7%

Crane
Annual Return 15.1%
Average P/E 13.4
Dividend 4.7%

Data source: Yahoo Finance

Why Dividends are the kicker for great returns
Those returns are calculated with dividends reinvested. In fact, as Siegel later explains, a healthy dividend, regularly redeployed, is the key to compounding average returns into long-term, market-beating gains.

This makes perfect sense. When strong companies suffer a down market, those dividends buy you more shares. When the markets readjust, you reap the rewards of those additional shares.