A certain group of stocks have outperformed the rest of the stock market by a wide margin: Sin stocks. Tobacco, alcohol, arms producers, the gambling industry, the cannabis industry and sex-industry can safely be labelled as sin stocks. In the US, tobacco stocks have been the best performers over the last century, while alcohol stocks have been the best performer in the UK. Just as an anecdotal observation just look at Swedish Match, a Swedish snus and tobacco producer which was IPO’ed in 1996: 18% annual returns since then.
There is a social norm against funding operations that promotes vice, particularly institutions are subject to those norms, and they subsequently abstain from investing in such companies. Thus, sin stocks are much more likely to have a bigger group of private and retail investors. Furthermore, because of lack of interest from big institutions, sin stocks get much less coverage from sell side analysts.
A lot of empirical research has been done to confirm the outperformance. For example, Marcin Kacperczyk og Harrison Hong published a paper in March 2006 titled The Price of Sin: The Effects of Social Norms on Markets. They looked at tobacco, alcohol and gambling stocks and they found a soldid outperformance of 0.5% per month. They tested against relevant industries like food, soft drinks, entertainment and hotels, but these industries also underperformed.
Altria, a tobacco producer, has since 1968 risen about 20% annually. One dollar invested in 1968 was worth 6 638 dollars in 2015, according to Jeremy Siegel in Stocks For The Long Run. For comparison, one dollar invested in S&P 500 was “only” worth 87 dollars in 2015! That shows the magic of compounding. If you invested one dollar in US industrial companies in 1900, it was worth 38 255 in 2010. But this dwarfs compared to tobacco stocks which was worth 6.3 million over the same period, according to Credit Suisse’s Global Investment Returns Yearbook 2015. During a century that saw a sharp rise in living standards and drastic reductions in poverty, nothing could beat the boring tobacco stocks which hardly saw their business change at all.
Tobacco is of course very bad for your health, which was known and documented in the 1960’s, still nothing could beat tobacco stocks (common sense suggest it’s unhealthy, why would nature give us lungs to inhale chemicals and other products?). Because of health issues, smoking per capita has dropped every year since the peak in 1970 in the Western hemisphere. At the same time many countries have implemented strict regulation and excise taxes on cigarettes, even advertising is prohibited in most places around the world. Furthermore, tobacco companies have paid billions upon billions in lawsuits and settlements. Despite all this, tobacco stocks have been a very good investment. One of the reasons is that the price of cigarettes have risen more than five times the inflation rate since 1950 (part of this is of course excise taxes). As the numbers of smokers go down, this is more than offset by the rise in price.
What are the reasons for the outperformance of sin stocks?
US Mutual has a fund called The Vice Fund, a fund that only invests in sin stocks. In their prospect they explain why sin stocks highly likely will continue to produce abnormal returns:
- Very high barriers to entry.
- Solid demand of their products no matter the economy.
- They are global players.
- High margins.
- Requires little capital to operate.
- High free cashflow that is handed back to shareholders.
- They trade at lower earnings multiple, which makes buybacks and dividend reinvestment more powerful.
- They don’t need to spend a lot on CAPEX and R&D.
- They products are “timeless”.
- Products are of course addictive.
- They are mostly highly regulated, thus the market works like an oligopoly.
The social norm against investing in such companies leads to lower valuation and earnings multiples. Kacperczyk and Hong’s research suggests sin stocks are valued about 15% less than the industries that are most similar. Bigger organizations like endowment funds, mutual funds, banks etc. are scrutinized by the media and thus are forced to not invest in these types of companies. Furthermore, sin stocks are “always” in some lawsuit from authorities or consumers. All these factors in turn means little interest from sell side analysts and this lead to lower multiples and higher future returns.
Julie Salaber wrote in 2007 a research paper called The determinants of sin stock returns: evidence on the European market, and she concluded that returns are bigger in protestant countries. These countries are more focused on deeds, vice and sins, thus lower valuations and better future returns.
Below is a table with just a random sample of sins stocks and their returns (source: Yahoo Finance):
|Lockheed Martin||LMT (NYSE)||Aerospace & Defense||14,8%||1980 – january 2019|
|Raytheon||RTN (NYSE)||Aerospace & Defense||13,8%||1980 – january 2019|
|Altria||MO (NYSE)||Tobacco||28,6%||1980 – january 2019|
|Brown-Forman||BF-B (NYSE)||Alcohol||25,6%||1995 – january 2019|
|Diageo||DGE.L (London)||Alcohol||11,2%||1995 – january 2019|
|Carlsberg||CARL-B.CO (København)||Alcohol||9,2%||2000 – january 2019|
|Constellation Brands||STZ (NYSE)||Alcohol||16,2%||1995 – january 2019|
|British American Tobacco||BATS.L (London)||Tobacco||12,2%||1995 – january 2019|
|Molson Coors Brewing Company||TAP (NYSE)||Alcohol||10%||1980 – january 2019|
|Northrop Grumman||NOC (NYSE)||Aerospace & Defense||15%||1980 – january 2019|
|Swedish Match||SWMA (Stockholm)||Tbacco/snus||18%||2000 – january 2019|
|Galaxy Entertainment Group||27.HK||Gambling (Macau)||25%||2000 – january 2019|
The world’s biggest sovereign wealth fund (SWF), Norway’s, has a long list of companies that are excluded from investment. From the list of my table above these companies are excluded: Lockheed Martin (nuclear arms), Northrop Grumman (nuclear arms), British American Tobacco, Altria and Swedish Match. As a sidenote (I’m a Norwegian citizen), I find it a little peculiar that the fund are not allowed to invest in Lockheed Martin, but at the same time The Norwegian Defense Ministry are ordering fighter jets from Lockheed Martin worth billions of dollars. The SWF has also invested in Canadian cannabis companies!
Is the outperformance likely to continue?
Are there fewer or more sin stocks around? Karita Troberg wrote in a master thesis from 2016 called Sin Stock Returns on European Markets that the the number of publicly traded sin stocks have increased from 23 i 1985 til 142 i 2015 inside the EU. Her conclusion indicates that a portfolio of these stocks from 1985 to 2015 returned 4.7% more annually compared to the broader market. One of Troberg’s conclusions is that the outperformance have increased over the last decade, mainly because of margin expansions. She believes more focus on ESG has made sin stocks even more attractive as an investment.