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Sin Stocks Investment Strategy (Why Unethical Stocks Outperform and How to Benefit)

Last Updated on 10 February, 2024 by Abrahamtolle

A specific group of stocks has outperformed the rest of the stock market by a wide margin: Sin stocks. We can also label these stocks “unethical stocks”.

Sin stocks outperform the market because the industry has high barriers to entry, high margins, requires little capital, the products are addictive, and regulation leads to oligopoly for the few players left.

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 in the UK.

As an anecdotal observation, look at Swedish Match, a Swedish snus and tobacco producer, which was IPO’ed in 1996: 18% annual returns since then.

Retail investors more likely to invest in sin stocks

There is a social norm against funding operations that promotes vice, particularly institutions that are subject to those norms, and they subsequently abstain from investing in such companies.

Thus, sin stocks are much likelier to have a bigger group of private and retail investors. Furthermore, because of a lack of interest from 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 dwarf compared to tobacco stocks 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 that hardly saw their business change.

Tobacco is terrible for your health, 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 yearly since the peak in 1970 in the Western hemisphere. At the same time, many countries have implemented strict regulations and excise taxes on cigarettes; even advertising is prohibited in most places worldwide.

Furthermore, tobacco companies have paid billions upon billions in lawsuits and settlements.

Despite all this, tobacco stocks have been an excellent 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 excise taxes). As the numbers of smokers go down, this is more than offset by the rise in price.

Why sin and unethical stocks outperform

What are the reasons for the outperformance of sin stocks?

US Mutual has a fund called The Vice Fund, which only invests in sin stocks. In their prospect, they explain why sin stocks are 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 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 at about 15% less than most similar industries.

Bigger organizations like endowment funds, mutual funds, banks, etc., are scrutinized by the media and thus are forced to not invest in these companies.

Furthermore, sin stocks are “always” in some lawsuits from authorities or consumers. All these factors, in turn, mean little interest from sell-side analysts, leading 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 focus more 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):

CompanyTickerIndustryCAGRTime period
Lockheed MartinLMT (NYSE)Aerospace & Defense14,8%1980 – January 2019
RaytheonRTN (NYSE)Aerospace & Defense13,8%1980 – January 2019
AltriaMO (NYSE)Tobacco28,6%1980 – January 2019
Brown-FormanBF-B (NYSE)Alcohol25,6%1995 – January 2019
DiageoDGE.L (London)Alcohol11,2%1995 – January 2019
CarlsbergCARL-B.CO (København)Alcohol9,2%2000 – January 2019
Constellation BrandsSTZ (NYSE)Alcohol16,2%1995 – January 2019
British American TobaccoBATS.L (London)Tobacco12,2%1995 – January 2019
Molson Coors Brewing CompanyTAP (NYSE)Alcohol10%1980 – January 2019
Northrop GrummanNOC (NYSE)Aerospace & Defense15%1980 – January 2019
Swedish MatchSWMA (Stockholm)Tobacco/snus18%2000 – January 2019
Galaxy Entertainment Group27.HKGambling (Macau)25%2000 – January 2019

The world’s biggest sovereign wealth fund (SWF), Norway, has many companies excluded from investment.

From my table above, these companies are excluded from Norway’s SWF: 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 peculiar that the fund is not allowed to invest in Lockheed Martin. Still, 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!

Are sin and unethical stocks likely to outperform the market?

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 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.

Sin Stocks: What They Are, How They Work, Pros and Cons

Introduction: Sin stocks, also known as unethical stocks, refer to investments in industries associated with morally questionable activities such as tobacco, alcohol, arms production, gambling, cannabis, and the sex industry. This subheading provides an overview of sin stocks, their characteristics, and the potential advantages and disadvantages of investing in them.

Definition and Function: Sin stocks represent shares of companies involved in activities that are generally considered vices or socially undesirable. These stocks tend to outperform the broader market due to factors such as high barriers to entry, addictive products, industry regulation leading to oligopoly, and solid demand regardless of economic conditions. Sin stocks generate revenue through the sale of products or services related to their respective industries, often capitalizing on addictive behaviors or timeless desires.

Pros of Investing in Sin Stocks:

  1. Potential for High Returns: Historical data suggests that sin stocks have outperformed the market over long periods, offering investors the possibility of significant returns.
  2. Lower Valuations: Social norms and ethical considerations lead to sin stocks being undervalued relative to similar industries, creating opportunities for value investors.
  3. Stable Demand: Sin industries typically exhibit stable demand, as their products often have addictive or timeless qualities, making them less susceptible to economic downturns.
  4. High Profit Margins: Sin businesses often enjoy high-profit margins, allowing for strong cash flow and potential dividend payments or share buybacks.
  5. Oligopoly Structure: Regulatory barriers and industry consolidation create oligopolistic market conditions, which can lead to pricing power and reduced competition.

Cons of Investing in Sin Stocks:

  1. Ethical Considerations: Investing in sin stocks may conflict with individual values and ethical standards, as these companies are associated with activities deemed harmful or socially irresponsible.
  2. Regulatory Risks: Sin industries are subject to strict regulations, which can lead to increased legal and compliance risks, potentially affecting profitability and stock performance.
  3. Social Stigma: Investing in sin stocks may invite criticism or negative public perception, as some individuals and institutions view these industries as morally objectionable.
  4. Litigation and Reputation Risks: Sin companies are often subject to lawsuits, consumer backlash, and reputational damage, which can impact their financial performance and long-term viability.
  5. Market Volatility: Sin stocks may exhibit higher volatility due to their sensitivity to regulatory changes, shifts in public sentiment, or adverse media coverage.

Conclusion


Sin stocks, also known as unethical stocks, have gained attention for their remarkable outperformance in the market. These stocks belong to industries associated with morally questionable activities, such as tobacco, alcohol, arms production, gambling, cannabis, and the sex industry.

One key factor contributing to the success of sin stocks is the high barriers to entry. These industries often require significant investments, regulatory compliance, and specialized knowledge, making it challenging for new players to enter the market. As a result, established sin companies enjoy a dominant position and can capitalize on their market share.

Another contributing factor is the addictive nature of the products associated with sin stocks. Whether it’s cigarettes, alcoholic beverages, or gambling services, these products create a strong consumer demand that persists regardless of economic conditions. This stability provides sin companies with a reliable customer base and consistent revenue streams.

Moreover, sin stocks often operate within an oligopoly market structure. Strict regulations and licensing requirements limit the number of players in these industries, leading to reduced competition and higher profit margins. The limited number of companies that can operate legally create an environment where market control is concentrated among a few players, allowing them to maintain pricing power and enjoy strong financial performance.

Despite the ethical concerns surrounding sin stocks, their valuation often reflects the social norms and investing behaviors of the general public. These stocks are typically undervalued compared to similar industries due to the stigma associated with their activities. This lower valuation can present opportunities for investors looking for potentially undervalued assets.

Interestingly, institutional investors show less interest in sin stocks compared to retail investors. Institutional investment firms, endowment funds, and banks often face scrutiny from the media and public, which may discourage them from investing in companies associated with morally questionable activities. This lack of institutional interest contributes to lower coverage from sell-side analysts, further affecting the valuation and earnings multiples of sin stocks.

Empirical research has shed light on the historical performance of sin stocks. Studies, such as the one conducted by Marcin Kacperczyk and Harrison Hong, have confirmed the solid outperformance of sin stocks by around 0.5% per month. These findings indicate that sin stocks have exhibited better returns compared to industries like food, soft drinks, entertainment, and hotels.

The tobacco and alcohol industries, in particular, have demonstrated strong historical performance. Tobacco stocks, such as Altria, have seen annual returns of approximately 20% since 1968. This exceptional compounding effect has resulted in significant wealth creation for long-term investors. Similarly, alcohol stocks, such as Brown-Forman and Diageo, have provided investors with attractive returns over the years.

However, investing in sin stocks is not without its drawbacks. Ethical considerations play a significant role, as these industries are associated with activities that many find objectionable. Critics argue that investing in sin stocks may conflict with personal values and contribute to the perpetuation of harmful behaviors or industries.

Furthermore, sin stocks face regulatory risks due to the nature of their activities. Governments often impose strict regulations, taxes, and limitations on these industries, which can impact profitability and stock performance. Additionally, sin stocks are subject to litigation and reputational risks, as they face lawsuits and consumer backlash. Negative publicity can harm a company’s image and potentially affect its financial performance.

In conclusion, sin stocks have gained a reputation for their outperformance in the market. The high barriers to entry, addictive products, oligopoly market structure, and social norms associated with these industries contribute to their success. However, investing in sin stocks requires careful consideration of ethical concerns, regulatory risks, and potential reputational damage. Investors should weigh the pros and cons of investing in sin stocks and align their investment decisions with their own values and risk tolerance.

Disclaimer: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.  

FAQ:

– What are sin stocks, and why are they sometimes labeled as “unethical stocks”?

Sin stocks refer to investments in industries related to activities that are often deemed morally questionable, including tobacco, alcohol, arms production, gambling, cannabis, and the sex industry.

– Are private and retail investors more likely to invest in sin stocks?

Yes, sin stocks are often attractive to private and retail investors because institutional investors may abstain from investing in companies associated with socially undesirable activities, resulting in a larger group of private investors.

– Why do sin stocks receive less coverage from sell-side analysts?

Due to the social norm against investing in such companies, sin stocks often have less interest from institutional investors, leading to reduced sell-side analyst coverage.

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