Often undervalued, with relatively inelastic demand and a sticky consumer base, barring the social debate surrounding them, sin stocks can in fact, be a great investment opportunity. Jayshree Poddar discusses how.
What Are Sin Stocks?
Sin stocks are the stocks of companies that are usually considered “unethical” or “immoral”. These include gambling, alcohol, adult entertainment, weaponry, tobacco etc. These are usually not an investor’s favourites since most wish to steer clear of getting their portfolios “dirty” by these...well, sins.
Sin stocks, more often than not, directly deal with sectors that indulge in activities that are frowned upon for exploiting human frailties. However, there is some gray area in deciding which stocks are sinful. After all, what is unethical for one might be ethical for another. For example, in the United States there has been a long-standing debate between the gun advocates and critics regarding gun control legislation. And in many countries, alcohol brewing is a celebrated tradition while in some it is frowned upon.
Businesses are generally judged by their ability to generate profits and cash flow over a sustained period, and from statistics, it may be concluded that markets do not value sin stock companies any differently than the others. Moreover, they’ve had similar price-to-earnings ratios and strong price-to-book numbers.
What Are The Advantages of Sin Stocks?
Sin stock companies present a wide range of advantages. They usually command a steady stream of consumers and hence are more or less predictable. They are resilient regardless of the economic climate, even during recession and are considered to be sound investments because of relatively inelastic demands of their customers and their services. Drinkers or smokers will continue to drink or smoke even when the economy tanks. This tends to keep profits up, allowing sin stock companies to pay generous and growing dividends.
Yet another benefit of investing in sin stocks is the fact that they are relatively cheap when compared to other stocks. This portion of the market is often ignored by conscientious investors, making these equities more prone to undervaluation and hence beneficial to investors, providing fat margins and solid profits.
Another vital point to be noted is the limited competition from rival companies. For example, in most countries the state issues a limited number of gambling licences, thus preventing too many competitors from entering the market. Reduced competition can make these industries more profitable for the existing players.
Apart from the many reasons listed above, a factor that tips the scales in favour of sin stocks is the compensation given to investors in the form of risk premium, since investment in these stocks may pose threats such as litigation risk and reputation risk to the investors.
All these reasons contribute to the trend of sin stocks generally outperforming their “socially conscious” counterparts.
Sin Stocks As Cash Cows
Cash cows are companies that stop growing but produce large amounts of cash through their established market positions.
Sin stock-owning companies are usually cash cows and they benefit from upcoming markets. Newer markets provide more avenues for the incomes of people to increase, pushing them to spend on services and commodities of the vice companies. This helps them maintain a strong and expanding global consumer base, ergo keeping the profits on an upward trajectory.
Also, probably due to a successful combination of fixed asset pricing models and limits on new investments, these operational efficiencies lead to greater profitability.
What Are The Disadvantage of Sin Stocks?
On the flipside, there can be some downsides to investing in sin stocks, despite the many perks noted above.
Some markets such as marijuana remain untested. Its legalisation is still in process in some countries and it has no clear market leaders. At this point, it might be difficult to tell which companies will turn into established thriving businesses.
Although sin stocks are predictable, they do have their own boom and bust cycles. Gun stocks, for example, had been on the decline for nearly two years between 2016 and 2018 before rebounding in third-quarter of 2018. Hence, it is not a completely risk-free zone.
One crucial pitfall in this type of investing is that the heavy excise duties, taxes and tariffs, bans, political influence and leanings, licensing, social and regulatory risks etc. discourage investors from entering this market. For example, last year the Rajasthan state government imposed a 20% cess on alcohol for cow protection. And in Karnataka’s 2018 budget the government hiked excise duty on Indian-Made Foreign Liquor by 4%.
Current Market Sentiment of Sin Stocks
The past year hasn't particularly been good for sin stocks; most of the major ones have been trading in the red. But with these stocks trending down, it might be a good time to stock up on a few of them and sit tight.
At the same time, it is also important to realise that not all stocks of a particular sinful industry have shown a downward trend. For instance, while mass beer brewers are off by more than 24%, craft beer king Boston Beer is up 42% this year and gunmakers American Outdoor Brands and Sturm, Ruger & Co. are trading 11% and 15% higher respectively.
Hence, it may be observed that sin stocks are a good investment in terms of returns due to their sturdiness even through the direst of economic conditions. They do present some risks (inevitable in the stock market) but can be regarded as a sound opportunity for those who do not feel guilty of buying them. There, however, is always the option of investing in “unsinful” stocks to preserve a clean conscience.
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