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Investing In The Sin Bin: Are 'Vice' Stocks Like Tobacco, Booze And Casinos Smart Bets?
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Does morality matter in investing? Put another way, can amorality pay off?
Four of Sullivan’s top five holdings are in tobacco companies, and for all the hand-wringing over the health hazards of smoking – and the massive settlements the companies have coughed up – he still thinks the stocks are among his best bets.
“You can’t just start a tobacco company,” Sullivan says, pointing out the wide moat enjoyed by the industry’s established players. While they undoubtedly face increased scrutiny, he’s fairly sanguine about their future and the potential market share threat from e-cigarettes.
“When you take a universe and start excluding for something that has nothing to do with investment theory, you’re using biases of exclusion that remove high-yielding stocks and will make it more difficult to keep up with or beat a benchmark,” Sullivan says.
Take Altria Group MO -0.1% for example. “If you exclude it you’re taking out one of the best stocks of the last 20 years,” says Sullivan. He’s right. Altria has returned more than 2,500% in the last two decades, better than the S&P 500′s 478% and ahead of much faster-growing companies like NIKE NKE +0.06% and Whole Foods Market WFM -0.59%.
Sullivan compares tobacco companies with “passbook savings accounts,” given their steady, consistent yields. Even some investors who were opposed to the sector years ago are finding their way back to the industry in a desperate search for income.
“If I offered you a 30-year U.S. Treasury at 3% or a tobacco stock at 4% which looks better?” the fund manager asks.
Academic studies support the argument for vice stocks that underpins the Barrier Fund, finding the group has “less institutional ownership and less analyst coverage than otherwise comparable stocks” and that social norms have “significant price effects.” According to researchers from Princeton University and the University of British Columbia , “sin stocks outperform comparables even after controlling for well-known return predictors.”
In February, Credit Suisse published a study out of the London Business School that found more of the same. The piece, authored by Elroy Dimson, Paul Marsh and Mike Staunton, noted that Sullivan’s vice-focused fund easily outpaced the returns of a Vanguard fund tracking a socially-responsible index of stocks since 2002.
“[M]uch of the evidence that we review suggests that ‘sin’ pays,” the study found, highlighting the key elements that make vice stocks compelling investments. “The rationale for ‘vice’ investing is that these companies have a steady demand for their goods and services regardless of economic conditions, they operate globally, they tend to be high-margin businesses, and they are in industries with high entry barriers.”
A recent report from SigFig found that 1 in 8 investors own at least one “vice” stock, which the company categorized as companies in the tobacco, alcohol, casino or marijuana industries. (The automated portfolio management firm, which partners with Fidelity, Schwab and Ameritrade , aggregated data from the 230,000 accounts synced with its platform that hold at least one stock.)
SigFig’s report considers a handful of stocks in each industry. Tobacco companies Altria Group MO -0.1%, Philip Morris International PM -0.51%, Lorillard LO +0.32% and Reynolds American RAI +0.17%; Alcohol companies Anheuser-Busch InBev , Molson Coors Brewing TAP +0.66%, Boston Beer SAM -0.36%, Craft Brew Alliance and Constellation Brands STZ +0.75%; Gaming outfits Las Vegas Sands LVS -0.67%, Wynn Resorts WYNN -0.78%, MGM Resorts MGM +0.25%, Melco Crown Entertainment , Boyd Gaming and Penn National Gaming ; and Marijuana stocks Medical Marijuana, Growlife, Hemp Inc and GW Pharmaceuticals .
(The latter group is a newer entrant into the vice category, given the legalization of marijuana , to varying degrees, across a number of U.S. states in recent years, and isn’t included in most of the academic work on the topic, or in Sullivan’s fund.)
It’s important to note that the SigFig report does not include any evidence that investors are buying these “vice” stocks because they’re attracted to the sinful nature of their products. In many cases, the stocks in question offer characteristics that could prove compelling to investors, like growth opportunities or dividend income, that have nothing to do with the perceived moral character of a company or its products.
Since some investors object to owning these stocks for moral reasons, the resulting inefficiency in their market valuation offers an opportunity to investors with no such compunction.
“If you wrapped these stocks in white paper and couldn’t tell what they were, people would love them,” says Sullivan. The four tobacco stocks in his top five holdings account for nearly a quarter of the portfolio, but the group will shrink by one when last summer’s announced takeover of Lorillard by Reynolds American is completed.
In the alcohol industry, a spate of merger activity has narrowed the choices for investors. The acquisition of Beam by Japan’s Suntory took the distiller of Jim Beam , Maker’s Mark and other brands out of the rotation, while the beer industry has consolidated into just a handful of major players.
Sullivan does point to Constellation Brands, which bought out its joint venture partner on U.S. distribution of Corona in 2012, as a bright spot for growth in the beer business. On the spirits side of things, he says companies like Brown-Forman , Diageo and others have felt the pain from China’s economic slowdown.
That slowdown, along with a crackdown on corruption, has proven a substantial blow to another piece of the vice puzzle as gaming companies have been hurt by weaker performance in Macau , what had been a critical growth market.
Sullivan sees casino operators as having a different role among his collection of sin stocks though. The group has been the chief cause of his fund’s rocky performance over the last few months, but that comes with the territory he says.
“Gaming is like yeast for the portfolio – if it’s working, the bread rises. If it doesn’t, you’re flat or you’ve got a bagel,” he says.
Watching his holdings in Las Vegas Sands, Wynn, MGM Resorts and their peers tumble hasn’t been fun, and Sullivan is realistic about the likelihood of a sudden comeback.
With such a significant portion of global gaming revenue coming from Macau, “it’s hard to say you don’t need a bottom in Macau for these stocks to get back on their feet,” Sullivan says. He points to Wynn’s proactive move to cut its dividend by two-thirds in late April as a clear indication that casino operators don’t expect the Macau slowdown to be a short-term problem.
His longer-term take is more upbeat though and he expects gaming companies to eventually resume fueling returns rather than anchoring them.
“Ultimately they’ll weather the storm and will be positioned for when the takeoff happen,” says Sullivan. “The fan got hit so bad with s—, eventually the comparables year over year will start looking better.”
