Sin stocks: drink, smoke and make money
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
In investment as in music, the Devil sometimes seems to have the best themes. British American Tobacco, the world’s number two cigarette maker has just unveiled a £2bn buyback alongside a 3 per cent rise in annual operating profits. The shares of distiller Diageo and gambling tech group Playtech have handily beaten the benchmark FTSE 100 over the past year.
So-called sin stocks should continue to shine as beneficiaries of the rotation from high growth to value stocks. BAT shows why: these businesses churn out cash like a fruit machine rigged in the favour of punters. Last year the group had £2.5bn of free cash flow after the dividends which gave the stock a steep yield of 6.5 per cent
For sure, vice carries big health warnings. One comes from the growing heft of sustainable investment. BAT nods to that with its growing portfolio of less toxic “non-combustibles”, including vapes. But 88 per cent of revenues still come from traditional tobacco; even a target of £5bn from non-combustibles by 2025 represents just one-sixth of total, assuming annual revenue growth of 4 per cent.
The second issue is regulatory: bans and taxes. Fruit-flavoured vapes have already been banned, leading to big writedowns in the sector. Tax collectors see vice as a rich source of revenues.
Yet sin’s financial attractions are backed by a mountain of academic research. Thank passive investors, obliged to hold these index heavyweights. Theoretically, investors need to be rewarded for taking on reputational risk. The sector’s high cost of capital — returned in the long run — implies a sin premium.
In the eight decades since the Wall Street crash US sin stocks outperformed to the tune of 3 to 4 per cent a year, according to one study. From 1970 to 2007 a sin portfolio compiled by Frank Fabozzi and colleagues returned an annual 19 per cent, almost triple the average stock market gains.
Strictly for the devil-may-care investor? Not at all. The more scrupulous can harvest returns from the moral high ground by using their votes to nudge businesses towards more ethical métiers.