2 Stocks and a Bonus Donkey

As the advisor of a stock newsletter that focuses exclusively on dividend-paying companies, I tend to leave the wild speculation to those who drill for oil. Instead, I focus on quality. After all, I'm not looking to make money for my subscribers next week only to lose it for them next year. I want them to own firms they can have faith in for decades -- investments they can leave to their children and, perhaps, their children's children.

Yes, we're still talking about stocks here, which all carry some degree of risk, so we'll continue to watch even these companies closely. But the point is that these aren't the kinds of stocks one hangs onto with sweaty palms and white knuckles. Of course, at the end of the day, to avoid risk you must first be aware of it, and that's what the following story is all about.

Vegas, baby!
My wife and I spent a little time in Las Vegas recently. We have good friends who make an annual trek to Sin City, and they're nice enough to offer us an open invitation to join them. Because of a somewhat hectic schedule, we were actually planning to sit out this year, but as luck would have it, I was asked to attend a convention there during the same week, so we ultimately took them up on the offer.

I don't mean to appear critical, because I actually find the city quite entertaining. But the truth is that Las Vegas is a Bermuda Triangle for money -- a place where all rules of financial reality and fiscal responsibility break down. No matter how many times you flick the gauge, the little needle on the ATM has simply gone haywire and always points left of zero. No matter what direction you travel, you're always surrounded by the same slot machines you just left behind -- it's creepy. What's creepier still is that in addition to losing money in the casinos, one also seems to lose time. (Unfortunately, this cannot be independently verified because there are no clocks on the walls.)

What can be verified is that most folks completely ignore the rules of the games they're playing. And as I've said before, in both gambling and investing, not paying attention to those rules will cost you.

The shakedown
Admittedly, this isn't entirely our fault. The casinos have gone to great lengths to hide the fact that we're facing risks at every turn. Bright lights, loud noises, and fancy murals are all designed to steal our attention from our dwindling chip stacks. And they often work.

Interestingly, the casinos take the same approach on the winning side, making it seem as if you've won the Hope Diamond instead of $40 in nickels. Heck, it's gotten to the point where it takes a Ph.D. to determine whether you've won. As an example, the hot new thing on the casino floor is the video slot machine -- and I don't mean the old video poker rigs. I'm talking about the new wave of theme-oriented slots based on everything from Star Wars to Phantom of the Opera. They use pictures associated with the theme instead of the traditional lemons and cherries and whatnot. To make it even more interesting, you play not just a single horizontal line, but up to 21 different combinations across three rows of characters. Confused yet? Just wait.

The truly intriguing thing about gambling on these machines is that one typically has absolutely no idea what constitutes a winning spin. For instance, my friend's wife played a medieval-themed slot, and for the life of us we couldn't determine how three fat dwarfs, a wheelbarrow, and a stack of hay made a winning combination. For encouragement, I offered the profound insight, "Wow, you'd probably be a millionaire if you'd landed one of those bonus donkeys!"

Now, beyond the obvious fact that I couldn't pass up the chance to use the term "bonus donkeys" in an article, I'm telling you this story because I've seen an alarming trend of folks carrying this same level of ignorance into their portfolios -- in terms of having a completely unrealistic view of both the upside and the downside risks in their portfolios.

For instance, stocks have historically achieved an annualized return of approximately 10%, but I've spoken with countless readers and seen surveys that suggest most investors anticipate a return closer to 15%, and a notable portion of them expect returns from 18% to 20%.

The Foolish bottom line
So what gives? Why are all these investors ignoring the norms? Well, despite some admitted hiccups, we've basically been in a long-term bull market since 1980, and when things go that well for that long, it's easy to become complacent and ignore significant risk factors. Don't. The only constant in any market is change. And in this market, there's no position I'd rather be in than the one we enjoy as dividend investors. I'm not all doom and gloom, mind you, but I believe that absolute returns are going to be extremely important in the years to come.

To that end, two of my favorite companies in today's market are Bank of America (NYSE: BAC  ) and Sysco (NYSE: SYY  ) . While they're attractive in any environment, they're especially appealing now based on three important metrics. First, they're both firing on all cylinders from an operational standpoint, and their respective businesses have never run more efficiently. Second, despite this operational excellence, based on my estimates, both companies are trading materially below their intrinsic values. And finally, they each boast a dividend yield that's well above that of the S&P 500 (AMEX: SPY  ) .

Bank of America is currently yielding 4.1% -- which you'll receive in good times and bad -- and the shares are trading about 15% beneath my $56 valuation estimate. Sysco yields a somewhat lower 2.3%, but it's trading at a more substantial 21% discount to its $37 valuation estimate.

I believe the typical portfolio can feed off positions like these for decades, using the energy to produce market-beating returns while exposing you to fewer overall risks. And unless you have a couple of bonus donkeys up your sleeve, it's going to take more companies exactly like these to achieve your long-term investing goals.

Fool on!

If you're looking to feed your portfolio and you need more stocks like the ones mentioned here to do it, join Mathew Emmert and your fellow dividend investors as our free guest. Each month Mathew provides his readers with the two best dividend-paying stocks for new money, and he also offers ongoing buy and sell advice on all past recommendations. In short, he's with you every step of the way, and that's The Motley Fool difference.

Try as he might, Mathew Emmert couldn't land bonus ducks, much less bonus donkeys, but he's thrilled with the number of times he got to use the phrase in this article. (Hey, life is about the little blessings, people.) Mathew is the advisor ofMotley Fool Income Investor, of which Bank of America and Sysco are recommendations. Mathew also owns shares of both of these companies within his personal accounts. The Fool's disclosure policy is no gamble.


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