Sin stocks may be frowned upon, but provide excellent investment opportunities. Are they worth it for the average investor?
Creating part of your portfolio with sin stocks can be a profitable investment strategy if you do it the right way. Be aware that these stocks generally attract a lower number of investors, as many people have reservations about investing in businesses they consider unethical. That doesn’t mean that the company can’t perform well and provide a reasonable rate of return, but you should consider the higher risk and liquidity issues.
As a pragmatic investor, we advise that you should be open to the possibility of investing in sin stocks, especially if you stand to make a good profit from it. Here is our comprehensive guide about sin stocks and factors to consider when investing in these companies.
What are Sin Stocks?
Sin stocks belong to companies that fall within the subcategory of the consumer products and services sector. Their products are generally considered unethical but are not illegal to purchase.
Stocks of companies that deal with tobacco, firearms, alcohol, gambling, legalized drugs, and sexual products are considered sin stocks. The products are generally frowned upon by the public as unsavory or harmful to the average consumer. Several investors do not buy shares in these companies based on ethics and principles.
Customers purchase these products, regardless of which way the economy is going. For example, a person addicted to alcohol or tobacco will still buy and consume these products even if the prices increase or the economy is in a recession. This is why sin stocks are not generally as negatively affected by market slumps as other consumer groups.
But consumption may not necessarily increase significantly when the economy is going through a period of boom.
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Benefits of Sin Stocks
The first rule of the market is that you should always approach trading with an open mind and look at ways to minimize risks. Investment in sin stocks presents opportunities for a smart trader. While some may consider it unethical, buying sin stocks is not illegal. Consumers generally make a well-informed decision about buying products and services.
Here are four reasons an investment in sin stocks can be useful for your overall market strategy.
1. Better Value
If you go through the shares market and research sin stocks, you will find many businesses financially stable, but their share price doesn’t reflect the value in the market. Investors who specifically ignore and avoid investments into sin shares are called Environmental, Social, and Governance (ESG) Investors.
Sin stocks are generally shunned by a significant portion of these investors. The lower demand keeps the price of these shares down, regardless of how well the company is performing at that moment.
The undervaluation of the sin stocks presents an opportunity for pragmatic investors who can get a good deal and create a good portfolio.
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2. Better Predictability
The demand pattern for vice companies is more predictable than regular businesses. This is because the demand is relatively inelastic regarding the market’s economic conditions.
Smokers are unlikely to cut smoking, and drinkers do not lower their alcohol consumption because of inflation. Gamblers and gun enthusiasts do not change their consumption patterns quickly. A recession can have an opposite effect on these businesses.
Smart investors care about risks in the market. They consider how consumers might react to changing economic conditions. Sin stocks present a relatively safer investment option because there is less uncertainty with these businesses, and demand is stable.
3. Defensive Investments and Cash Cows
The firearms industry is closely linked to the U.S. Government’s defensive expenditure. Over the last 30 years, the U.S. defense budget has either increased significantly or at a lower rate, and there have been very few cuts.
Much of the defense spending is invested in long-term projects that generate positive cash flows for the business. Defense contractors are building cash cows expected to pay our good dividends over several years. This presents a viable investment opportunity for investors that aren’t looking to grow their investments but want to earn a regular annual income on their investment.
4. Huge Returns
Several investment analysts performed studies on sin stocks and their historical performance. The findings were fascinating and noted that most sin stocks reported huge profits and paid out significant dividends to investors despite the investors’ reluctance to engage in the purchase of these shares.
The explanation was that sin stocks actually do not pay returns out higher than other companies. However, since the stocks are underpriced, the rate of return on the actual investments goes up and makes them seem more lucrative than regular shares.
Another explanation was that sin industries benefit from monopolistic returns as many business entrepreneurs are unwilling to enter these industries due to moral or religious reasons. This leaves the door open for existing businesses to create strong brands and gain monopolies in the market that enhances their profits.
Risks of Sin Stocks
Every type of investment comes with risks, and sin stocks are no different. Interestingly, the risk for these businesses does not come from the consumers, but government regulators and the legislative bodies.
Businesses operating in the sin sector are legal, but there are questions associated with their ethical nature. Social pressure and demands from pressure groups can turn national mood and lead to the banning of these products.
Consider the alcohol industry that went through a period of prohibition in the U.S. during the 1920s. Today, the tobacco and alcohol businesses operate under strict licensing requirements, and consumers are charged special taxes on sales to discourage usage.
Drugs like marijuana are only getting legalized, and a change in national mood may cause the government to ban them again. A strong anti-gun lobby in the U.S. keeps pushing for the complete ban of firearms; individual states have taken initiatives for gun control.
The risks faced by businesses operating in the vice market are real, and investors should carefully measure how risky the investment is before buying these shares.
Investor Checks for Sin Stocks
There are diligent steps that you can take to make a reasonable profit on sin stocks without taking on too much risk. Here are some things that you should consider.
Do Not Invest in Sin Stocks Only Operating in One Area
The funny thing about morality is that every society can have a different standard for what is or isn’t right. Take alcohol or firearms, which are banned in some parts of the world but acceptable and encouraged in others. Gambling and drugs are illegal in individual states of the U.S., but are significant industries in states like Nevada and Colorado.
When you invest in sin stock, spread out your investments in different parts of the country. Be smart about your investment and understand the public mood about the vice in the local economy to ensure that your target company doesn’t suddenly get banned by the state authorities.
You can also invest in businesses from countries other than the U.S. when investing in sin stocks. Several successful tobacco and alcohol businesses on the stock market operate from Europe and Asian countries. The risk of U.S. government bans is low on these foreign companies.
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Keep an Eye on Consumer Trends
We previously noted that trends for vice products are relatively stable in the short term. However, they can change significantly over a long while. Take the alcohol industry, which has experienced a boom in the market for several years, and market demand is today higher than it was ten years ago.
If you are serious about investing in sin stocks, then you should keep an eye out on consumer trends in your preferred industry. Market surveys and trend reports get published fairly frequently for sin stock. They can be a useful guide for you on when to invest in these stocks and when to sell them off before a period of decline sets in.
Also, try to stay up to date about public mood and government plans for the industry. Things can change quickly, in a matter of years sometimes. Take the U.S. marijuana market that legalized drugs in a matter of decades while gun control has become a hotly debated issue suggesting we might be headed for stricter gun control.
Adjust your strategy according to market trends and government policy.
Consider the Market Pragmatically
Take account of how other investors are thinking. Although many investors in the market do not invest in sin stocks, you will find plenty of pragmatic investors that specialize specifically in this industry.
There is no ultimate good vs. evil for making a profit. You must be very careful about your investment strategy. Do not get caught up in what others are saying or let your investment decisions be guided by the debate over good or bad ethics. To make a profit in the sin stocks, you should be rational and look at businesses in terms of performance and profits.
Look at the Liquidity Risks
Stock liquidity involves the ability to buy or sell stock quickly due to availability of other traders in the market. A stock with limited trade volume can be risky because your investment may get stuck if you can’t sell the shares, even at a loss.
Since sin stocks are avoided by many investors for ethical reasons, make sure that any sin stocks you are looking to invest in are traded reasonably regularly in the market so you can sell them out when you want to leave.
Best Sin Stocks to Buy in 2019
There are dozens of businesses listed at the exchange that can be classified as sin stocks. Here are five reasonably stable sin stocks to invest in 2019 to diversify your business portfolio.
- Altria is a prominent U.S. tobacco corporation built on a strong foundation. The Marlboro brand is one of the most popular in the world. The company has consistently offered dividends and is considered a good cash cow investment stock.
- Constellation Brands Inc. is an alcohol and beverages marketing company with over 40 facilities and more than 9,000 workers around the world. Famous brands include Mondavi, Ravenswood, Wild Horse, Franciscan, and Cios du Bois, among others. The business dividend has lowered in recent years, but it remains a good company for long term investment.
- Diageo Plc is one of the world’s largest alcohol distillers. Popular brands include Smirnoff, Johnnie Walker, Baileys, and Guinness. It has also continued to payout dividend annually and shows good growth prospects.
Sin stocks offer a unique set of opportunities and risks. Generally, they are undervalued in the market because a select group of investors avoids buying them. This makes even an average return on these shares very lucrative for investors.
However, sin stocks are riskier because their products are considered a cause of social vice and problems. The business must ensure its operations are licensed and do not fall on the wrong side of the law.
As a pragmatic investor, be willing to consider investing in these stocks, especially if they can give you a good return. Study the company and talk to a seasoned investment consultant if you need advice.