Last Updated on December 4, 2020 by Oddmund Groette
A certain group of stocks has outperformed the rest of the stock market by a wide margin: Sin stocks. Tobacco, alcohol, arms producers, the gambling industry, the cannabis industry and the sex-industry can safely be labeled 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.
Sin stocks outperform because the industry has high barriers to entry, has high margins, requires little capital, the products are addictive, and regulation leads to oligopoly for the few players left.
Retail investors more likely to invest in sin stocks
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 a lack of interest from big institutions, sin stocks get much less coverage from sell-side analysts.
Sin stocks have outperformed
A lot of empirical research has been done to confirm the outperformance. For example, Marcin Kacperczyk and 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 solid outperformance of 0.5% per month. They tested against relevant industries like food, soft drinks, entertainment and hotels, but these industries also underperformed.
Altria has been a success
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 the 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 were 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 1960s (common sense suggests 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 has 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.
Why do sin stocks outperform?
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 for their products no matter the economy.
- They are global players.
- High margins.
- Requires little capital to operate.
- High free cash flow 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.
- The 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, mean little interest from sell-side analysts and this leads 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.
The performance of some random sin stocks:
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)||Tobacco/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 side note (I’m a Norwegian citizen), I find it a little peculiar that the fund is not allowed to invest in Lockheed Martin, but at the same time The Norwegian Defense Ministry is 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 number of publicly-traded sin stocks has increased from 23 in 1985 to 142 in 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 has 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.