“Sin stocks” are publicly traded companies that sell controversial or even taboo products and services — from alcohol to cigarettes to gambling to guns to pornography.
So the question is, why would you want to invest in sin stocks?
Perhaps we should start with the broader question — why would you want to invest in anything? — then we can drill down to understand how sin stocks factor into this decision.
WHY PEOPLE INVEST
There are many reasons why people invest money but often it comes down to the simple balance between risk and reward.
- Investors want as much return as possible.
- Investors want as little risk as possible.
But it’s not one or the other — it’s a balance between both: Investors want to earn the highest possible reward for the lowest amount of risk they are comfortable with.
The interplay between risk and reward in ANY investment (not just stocks) is fundamental to understanding how investors think and why they choose the investments they choose.
One investor might be willing to accept a lot of risk in order to get the highest reward possible. A different investor might not want very much risk at all, so they’re willing to give up the potential rewards they can earn.
Consider two investors who might illustrate these two extreme positions:
- Alex is a 24 year old with a secure, high-paying job, no debt, and no dependents. He’s in good health with many good years of income-earning potential ahead of him. He even has a small inheritance from a deceased relative. Not surprisingly, Alex is has a lot of money to play with and he’s willing to “bet big” on an investment and even accept the risk of a substantial loss because he has plenty of time to bounce back if he loses money on an investment.
- Bill is 65 years old and has worked at a blue-collar job his entire life. He has barely any retirement savings and he’s in relatively good health so he knows that he has to make his meager retirement funds last for maybe 25 to 35 years. Bill does not want to invest his small amount of savings in anything risky because he’s going to need that money when he retires shortly, and he wants it to be there for him. He invests his money in the hopes that it grows but he chooses predictable, low-yield returns that are ultra safe.
These are two common yet extreme positions that illustrate the risk/reward balance. One person accepts high risk for high reward; the other is willing to give up a lot of reward because he doesn’t want the risk.
All investors fall somewhere in a spectrum between these two extremes. Mostly likely, you’re not quite in the extreme but somewhere else in the spectrum.
As an investor, you need to understand exactly how much risk you’re willing to accept in exchange for the potential reward you’ll earn from that investment.
STOCKS HAVE INHERENT RISK AND REWARD
No matter where you are on the spectrum of risk versus reward, there is an investment for you.
- On the high risk, high reward side of the spectrum, you might be looking at a wide variety of advanced strategies, high-risk stocks, and alternative assets, including options, shorting, penny stocks, and FOREX.
- On the low risk, low reward side of the spectrum, you might be looking at stable, predictable, safe, and guaranteed investments, like AAA bonds.
Again, most investors are somewhere in between. If you are comfortable with a moderate amount of risk and reward, you might be seeking out investments that are likely to be safe, not likely to plummet any time soon (but perhaps won’t massively skyrocket either), and are affordable based on a price point you are comfortable with.
Perhaps you like the thought of a professional fund manager analyzing stocks and deciding what to hold for you, so you might invest in a fund; or maybe you are like Warren Buffett and prefer familiar, predictable blue chip stocks. Or maybe you like the edgy, volatile world of small cap stocks. All stocks fall somewhere on the spectrum — some offering higher reward and higher risk, others offering lower reward and lower risk.
That leads us to the next point…
RISK/REWARD FACTORS DIFFER FOR EVERY INVESTOR
As you’ve seen, each investor places a different value on risk and reward. What’s more, each investor evaluates their levels of risk and reward based on different things.
- Industry — a risk-averse investor might want to invest in an industry that is predictable with steady growth; a risk-tolerant investor might want to invest in an industry that is booming right now with plenty of innovations and acquisitions.
- Stock price — to a risk-averse investor, a low-priced stock might suggest that it doesn’t have much to drop before they lose all their money; to a risk-tolerant investor, a low priced stock might mean that even a small jump in price could dramatically increase the value of their portfolio.
- Stock price volatility — to a risk-averse investor it could mean that a significant potential loss; to a risk-tolerant investor it could mean a significant potential gain.
- Management team — a risk-averse investor might want to know who the company’s management team is and how experienced they are at maintaining the long-term value of the company; a risk-tolerant investor might want to know that the management team is made up of bold thinkers and risk takers who are willing to bet big to grow the company.
Of course we’re just scratching the surface here of the various factors that each type of investor might evaluate against their risk/reward profile.
These same factors exist in sin stocks — offering some attractive investing options to risk-averse investors and some attractive investing options to risk-tolerant investors.
MAKING SENSE OF THE BIG INVESTING WORLD
There are thousands of publicly traded companies out there, so how does an investor find the right ones for them? How does an investor identify the factors that are important to them, that help them identify which stocks are appropriate for their level of risk/reward and, of THOSE stocks, which ones they should invest in?
To help them, investors divide up stocks into different informal groups. These groups may overlap with each other, depending on the metric used. Sometimes an investor might divide up the stocks into…
- industries (transportation, airline, restaurants)
- market capitalization (small cap, large cap)
- stock price (penny stocks)
- market activity (volatile, stable)
… the list can go on and on.
It’s a way to narrow your focus then compare “apples with apples” when trying to choose a stock and determine the potential risk and reward of each stock.
RISK AND REWARD IN SIN STOCKS
Within the big basket of publicly traded stocks available, there are sin stocks, which is an informal term for shares of companies that that sell controversial or taboo products and services like alcohol, tobacco, firearms, marijuana, pornography, gambling, and more.
Even within the narrowly defined term of “sin stocks”, there are a lot of sin stocks (see the comprehensive list of sin stocks from around the world here), and these stocks are scattered across the risk/reward spectrum.
There are volatile small cap sin stocks and there are great big, stable, predictable blue chip sin stocks. So there are sin stocks for every risk/reward preference. But this is a way to limit the stocks and compare apples to apples.
THE FACTORS THAT INFLUENCE RISK/REWARD IN SIN STOCKS
Just as all stocks have factors that influence risk and reward, so do sin stocks. And risk-averse investors might appreciate some of these while risk-tolerant investors might appreciate others. But we’ll list a group of reasons below…
- The returns on a sin stock investment can be solid. (According to an article in the Wall Street Journal, “A study… shows that over the past 115 years, U.S. tobacco stocks returned an average of 14.6% annually, compared with 9.6% for U.S. stocks.” (Source: WSJ, ‘Sin-Vestors Can Reap Smoking Hot Returns, February 13, 2015)
- Many sin stock companies have historically provided higher, predictable dividends.
- Some of these products/services are thought to be “recession-resistant” because (for example) people rarely reduce their smoking during a stressful economic downturn, even if they cut back on other expenses; and other people want to gamble more because they’re hoping for a windfall to get them through a recession.
- There’s a “moat” around the industry because it’s not easy to start a cigarette company or a casino or a marijuana farm or a distillery.
- Sin stocks tend to face a lot of litigation and risk of litigation.
- Sin stocks are often heavily taxed.
- Sin stocks are often considered unethical.
- Many sin stock companies sell products or services that are consumable and therefore need to be purchased again and again.
- Many sin stock companies sell products or services that are typically thought to be “addictive”.
These are just a few of the reasons that investors might think about investing in sin stocks.
But fundamentally, people invest in sin stocks for the same reason they invest in anything else — because they find a stock that matches their risk/reward preferences. Investing is a business decisions (albeit influenced by emotion and ethics) and an investor will invest in sin stocks, or any other investment, because they hope to get the highest potential return for the lowest possible risk.
And to some investors, some sin stocks provide exactly the right balance for them.