Investing has its risks and its rewards, and it is the job of the investor to carefully consider the threat that the risks represent and compare those against the promise of the rewards. When risk outweighs reward, the investment should usually be avoided; when reward outweighs risk, the investment should usually be acquired.
Additionally, each type of investment has its own risks, and investors need to take those specific risks into account. So what are the risks of investing in sin stocks? In this blog post, we’ve listed a number of risks, including risks that sin stocks share with all other investments, as well as risks that are almost exclusive to sin stocks themselves. We’ve also listed what we believe to be the severity of the risks.
SIN STOCK RISKS
Business risk: The risks associated with the changing business climate. For example, a labor strike at a manufacturing plant or a poor management decision might cause the business to stumble. Verdict: We believe this risk can be quite severe since these problems could potentially disrupt supply.
Economic risk: Sometimes linked with business risk, political risk, and market risk, economic risk is the risk of the impact of an economy on a business. A strong economy can boost consumer confidence, which can increase purchases; a weak economy can lower consumer confidence, which can reduce purchases. Verdict: We believe that, overall, most sin stocks have some room for fluctuation in any economy so we see this as a less-severe risk. With the exception of a catastrophic economic failure, we expect most sin stocks to continue relatively intact.
Foreign exchange risk: The risks associated with increases and decreases in the value of currencies. For the sin stock itself, profit margins might be put at risk if one currency rises dramatically against another (i.e. in a situation where the company buys raw materials in one currency and sells them in another). For investors, foreign exchange risk exists if the investor buys stock in a different currency than their domestic currency and those currency values change against each other. Verdict: This is a moderate risk with the potential to become worse if the global economy worsens.
Inflation risk: The risks associated with rising costs. Inflation can drive up raw material prices, eating into profit margins, and inflation can drive up product prices and potentially force people to stop buying the company’s products and services. Verdict: We believe this risk is less severe since we find most sin stock customers to be willing to spend more for their favorite indulgence.
Liquidity risk: The risks associated with the ability to buy or sell a stock quickly due to the lack of other potential buyers and sellers of that stock. Verdict: For most sin stocks, this isn’t a problem. However, some sin stocks (especially OTC stocks or stocks on foreign exchanges) might pose a greater liquidity risk.
Market risk: The risks associated with buying and selling stocks. At the macro level (and related to economic risks, above), prices could drop because of an economic scare and investors try to exit the market en masse. At the micro level, market risk could exist because of lack of liquidity or because of a negative news item about a specific stock. Verdict: We believe this risk to be moderate, likely impacting sin stocks in the short term only. Over the long-term, we believe this risk is relatively minor.
Political risk: The risks associated with political change. Government policies can influence how a company operates and how consumers purchase. More restrictive government policies can potentially result in lower sales. Verdict: We do not see this as a problem for several sin stocks. Prohibition and changes to cigarette marketing did not kill the use of these products. Currently, conflict sin stocks are gaining headlines because of gun violence. However, gun purchases have not diminished.
Social risk: This risk is almost exclusively a risk of sin stocks alone. Social risk is the risk of investing in a company that is socially unacceptable. Currently, social values “allow” (or at least turn a blind eye to) the gamut of sin stocks. However, some sin stocks are more acceptable than others and those social values shift over time. What is acceptable today may not have been acceptable yesterday and might not be acceptable again tomorrow. The biggest example right now are conflict sin stocks — including gun manufacturers — who may see declines in gun purchases. (Note: This hasn’t happened yet but we are using it as an example of something that could happen).