Vice Stocks: A Sin Not To Have In Your Portfolio

By Josh Kincaid
Summary

• Protecting your portfolio during economic uncertainty with sin stocks

• Sin clauses, SRI and ESG may come at a financial cost 

• Sin stock’s benefits in addition to being recession-proof, generating strong and consistent earnings, and having limited competition

• Historical evidence on the performance supports sin stock’s higher alpha

• Sin stocks plausible underperformance due to “shunned-stock hypothesis”

Vice Stocks AKA Sin Stocks

During my career in finance, I’ve been hearing investors say that vice stocks, AKA sin stocks, tend to outperform blue-chip stocks during a market downturn.

Sin stocks refer to shares of public companies whose business is considered unethical, immoral, or unsavory. Traditionally, the term's been applied to alcohol, tobacco, gambling, and defense.

Now that cannabis stocks are included in this segment, I was curious if more investors should be seeking alpha in sin stocks.

See also: Legal Weed: Cannabis Dispensaries, Marijuana Stocks And How It All Works

In order to get some more clarification on the subject, I reached out to an expert in this field- Larry Swedroe, who in August 2020 wrote the article “Sin Stocks And Expected Returns” which prompted me to seek out an interview with Larry for my cannabis business podcast “The Talking Hedge” to get into the weeds regarding sin stocks.

Sin’s Stability

According to Larry “sin stocks are considered to be fairly recession-proof. There’s a reason for this- people drink, smoke, and gamble in both good times and bad, while most of them don't view their own "sins" as discretionary. One theory for sin stock’s higher returns is they are more profitable and less wasteful with investment. This is due to the difficulty this sector has when it comes to raising capital, so companies don’t tend to waste it.”

Larry goes on to say “sin stocks are considered defensive and tend to remain fairly stable under difficult economic conditions. They tend to suffer only when economic conditions are so bad they impair consumers' ability to spend. However, consumers typically revert back to their vices once the economy improves, and they tend to spend aggressively during bull markets.”

Sin Stock Price Discovery

Prior to my research on sin stocks, I was under the impression the reasons for above-market returns was due to the demand for their products being inelastic.

After further research, sin stocks are in part systematically underpriced because of institutional investors' inability to buy them due to sin clauses, as well as those who lean toward the side of Social Responsible Investing (SRI) or Environmental Social Governance (ESG). These investors express their values through their investments and believe sin industries could benefit from monopolistic returns, or maybe these companies could face increased litigation risk for which investors are rewarded.

Shunned-Stock Hypothesis

This so-called "shunned-stock hypothesis" allows other investors who are willing to invest in sin stocks to earn a premium from the reputation risk. This means that socially responsible investors pay a financial cost when avoiding these stocks because of social and ethical criteria.

See also: More Sustainability, Less Carbon: BMW Commits To Hemp And Recycling

In other words, if enough people avoid a group of stocks then their valuations will be lower, which means the expected returns are now higher. On the other side of the coin, traders are utilizing the strategy of investing in sin stocks, like cannabis companies, to protect their portfolios during economic uncertainty. 

Benefits to Sin Stocks

Sin stocks have a lot of benefits in addition to being recession proof, generating strong and consistent earnings, and having limited competition. Sin stocks also tend to have better value, predictability, and a higher alpha.

The Evidence    

Historical evidence on the performance of these stocks supports the theory that sin stocks have provided significantly higher returns than stocks in general.

UBS UBS, for example, found that the 50 largest sin stocks greatly outperformed the MSCI World Index over the last 43 years, by about 5 percent annually, although there’s been a slide in performance over the past three years. This could be from a shift away from equities and more towards cryptocurrency, as crypto, alt coins, and defi continue to gain in popularity.

Crystal Bong Predictions

So what could investors expect to see if a wave of people start dumping shares as they flee other investment vehicles due to a market downturn, recession, depression, or market correction?

We might see a repeat of what happened during the 2000-02 downturn; Standard & Poor's Casinos and Gaming index gained 115 percent, while the S&P 500-stock index plunged 47 percent. Shares of tobacco giant Altria MO (then known as Philip Morris) more than doubled, and the stock of Anheuser-Busch BUD, the largest U.S. brewer, advanced 87 percent.

See also: Study: Marijuana Use May Double Chances Of Heart Attack In Young Adults

In Larry’s article, he sites the authors Harrison Hong and Marcin Kacperczyk of the study “The Price of Sin: The Effects of Social Norms on Markets,” published in the July 2009 issue of the Journal of Financial Economics, which found that for the period 1965 through 2006, sin stocks in seven large European markets and Canada outperformed similar stocks by about 2.5% a year.

Expected Returns 

Investors looking at sin stocks should expect a premium, although it's possible sin stocks underperform because of the shunned-stock hypothesis. 

The shunned-stock hypothesis states that sin stocks will have a higher cost of capital because they would trade at a lower price-to-earnings (P/E) ratio, which provides investors with higher returns.

Larry also mentioned during our interview that unless people stop sinning, the earnings should continue to be there, as well as generate above-market returns. However, he also said it’s plausible sin stocks could suffer through a period where cash flows are overwhelming those higher earnings relative to the price, so investors need to have long-term discipline- which you should have with any investment.

Full interview with Larry Swedroe available at “The Talking Hedge” or your favorite podcast platform, just search “Cannabis Investor Insights: Buckingham Wealth Partners.”

Sin Stock Non-Inclusive List:

Firearms

• Smith and Wesson SWBI is the leading handgun producer in the United States. 

• Sturm and Ruger Company RGR

The main ammunition manufacturer in the United States: 

• Olin OLN 

Defense

• Boeing BA

• iShares U.S. Aerospace & Defense ETF ITA

• Vanguard Consumer Staples Index Fund ETF VDC

Gambling

• Las Vegas Sands LVS

• MGM Grand MGM

• Boyd Gaming BYD

• Penn National Gaming PENN

Tobacco

• Philip Morris International PM is known for Marlboro

• British Tobacco Company BTI is home to Lucky Strike 

• Imperial Tobacco IMBBY is the largest seller of cigars

• Altria MO owns Philip Morris USA and U.S. Smokeless Tobacco Company.

• • $MO treated investors to 20% annual returns on average since 1968, while growing its dividend payout. 

Alcohol

• InBev’s 2008 acquisition of Anheuser-Busch Corporation BUD 

• Boston Beer SAM, Molson Coors TAP. 

• Brown-Forman (NYSE: BF-A) owns Jack Daniels. 

• Diageo DEO owns and distributes such well-known brands as Johnnie Walker, Guinness and Captain Morgan.

• • $DEO has had 10% annual returns for the past 10 years and paid nearly 40% of the purchase price in cash dividends.

Cannabis

• Constellation Brands STZ, is an alcohol and beverages marketing company with over 40 facilities and more than 9,000 workers around the world.  

• ETFMG Alternative Harvest ETF MJ

• Advisor Shares Vice ETF VICE

• • While the S&P 500 Index returned 7.8% per year, $VICE (previously $ACT) returned 11.5%. The vice portfolio exhibited less market risk measured by volatility than the S&P 500.

Lust

The strip club business in America is highly regulated by local governments in the vast majority of locations. As a result, the barriers to entry are high. One cannot just decide to open a strip club. Obtaining a license and owning the real estate is necessary.

• RCI Hospitality Holdings, Inc. RICK

Sloth

• Electronic Arts EA, Take-Two Interactive TTWO, VanEck Vectors Gaming ETF BJK

Anger

• World Wrestling Entertainment WWE 

Gluttony

• McDonald's MCD, Krispy Kreme Doughnuts DNUT, etcetera- take your pick!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Más contenido sobre cannabis en Español en El Planteo.

Photo: engin akyurt on Unsplash