Market Update - Are ‘sin’ stocks worth another look?

Market Update

Are ‘sin’ stocks worth another look?

So much attention is currently focused on ‘doing the right thing’ when it comes to investing your money. It’s no longer enough for fund managers to look for companies likely to offer investors the best returns. Now they must tick the ‘responsibility’ box. The slogan ‘doing well by doing good’ suggests that investing in a manner consistent with ESG (Environmental, Social and Governance) investing can pay off. In other words, it’s possible to construct a portfolio that only contains companies that tick a few ESG boxes, while excluding the obvious sin stocks, and make superior gains. That may be true. But overall, studies suggest that the jury is still out on this one.

Just a fad?

If there has been a recent outperformance of so-called socially responsible companies, then this could simply illustrate the current fad of switching out of ‘sin stocks’ and into more worthy ones. As ESG investing has risen in popularity, more money is being channelled into buying the funds and shares of companies that tick the ESG box. The flip side is that companies which are seen as beyond the ESG pale, such as tobacco, energy, defence, and gambling companies, have seen shareholders desert them. Could this be an opportunity for those investors more interested in making an above average return on their capital, rather than ‘doing the right thing’?

Definition is everything

This does rather depend on what one’s definition of an ethically responsible company is. Sin stocks are a bit more obvious to identify. Typically, sin stocks include those of companies involved in tobacco, arms manufacturing (defence), gambling, alcohol, miners, and energy companies still using fossil fuels. But you could add drug companies, food manufacturers, and chemical manufacturers, depending on your own set of values. In fact, it would be possible to exclude most companies in the major global stock indices if one had a mind to.

Nothing new

Ethical investing in one form or another has been around for many years. It seems to have gone along lines of what is or isn’t fashionable at any one time. It could be arms manufacturers, then tobacco stocks. More recently it’s been miners and oil producers. But ethical investing has always been controversial. For instance, is Rolls Royce a straightforward engineering concern, or an arms manufacturer? And one person’s ‘green’ company may be another’s ecological vandal. Consider electric vehicles. A Tesla may be more environmentally friendly than a diesel-powered Mercedes, but both are exclusive modes of transport that few people can afford. The components of Tesla’s battery, such as cobalt and lithium, are extracted by mining techniques which come at great environmental and human cost. Is that really so much better than running a car on fossil fuels? From manufacturing through to eventual scrapping, maybe so. But if a perfectly viable petrol-fuelled car is dumped and replaced by a brand new EV on the back of some governmental edict, then perhaps that isn’t so good.

 

 

The ‘sin’ conundrum

Other sin stocks include businesses that are heavy polluters or those that engage in poor labour practices. BP would seem to be an obvious example of the former, despite the greenwash that covers the oil giant’s website. But it could be argued that for as long as we rely on fossil fuels, which looks like being a significant length of time, maybe BP is in some ways an ethically responsible energy choice, as it may be more aware of its environmental responsibilities than other smaller, less public oil companies. High profile tech companies such as Amazon and Uber can tick plenty of boxes for ethical investors, but both could be considered sin stocks due to their poor record when it comes to their treatment of their employees. I think it’s fair to say that one person’s ethically responsible company is another person’s sin stock, which makes things complicated. And it’s no good looking for an ESG-compliant Exchange Traded Fund to make the decision for you.  As the Capitalist Exploits newsletter recently highlighted, the iShares ESG USA Index has a 2.5% weighting to oil and gas stocks which is much the same as the S&P 500.

Making money

But how is it possible to make money out of sin stocks? If investors continually shun them then surely, they will always be undervalued. The fact that they are less in demand than, say, growth stocks such as Apple, Alphabet, Facebook, and Tesla means they will remain undervalued, but also more stable. Sin stocks are typically shielded from economic and geopolitical developments. Drinkers didn’t stop drinking because there was a pandemic going on, quite the opposite. And gamblers haven’t stop gambling because inflation is going up. Most of us still rely on fossil fuels to drive our cars and heat our homes, and we’ll continue to do so no matter what poorly considered environmental targets get thrown up by governments. Most regrettably, wars and security threats will always be with us. Overall, there’s a solidity and predictability in sin stocks because demand is always there. Predictability in revenues and profits, even in recessions, means many of these companies reward their investors with healthy dividends, even if their product is far from healthy.

Be careful out there

So never fear, there are plenty of investors out there prepared to hoover up what more discerning players are willing to shun. It’s easy to find sin stocks, just ‘google’ it. Then you’ll find long lists of the top bad-boy companies, including brewers and tobacco companies, arms manufacturers, and gambling outfits. There are also a Vice ETF to help you get started. But, as with any form of investing, make sure you do your own homework and due diligence. Keep diversified, and don’t trade, especially on leverage, with money you can’t afford to lose.