Tobacco. Alcohol. Junk Food. Firearms.
Welcome to stock market hell, where cardinal sins are lucrative investment opportunities.
If you are an ethical investor, stop reading this article.
Seriously, just close the tab.
If you like controversial investments, read on.
Here are 7 sin stocks you should consider adding to your portfolio.
1 – TOBACCO
34 million Americans smoke cigarettes.
Altria Group (NYSE: MO) is one of the biggest tobacco companies in the world. It owns Marlboro and Philip Morris, two of the leading cigarette brands. In addition, it has a 10% equity stake in Anheuser-Busch InBev (world’s largest brewer), a 35% economic interest in JUUL Labs (n°1 electronic cigarette in the USA) and 45% ownership in Cronos Group (leading marijuana producer).
My immediate concern is Altria’s disappointing stock price history: On June 5th, 2015, Altria stock was trading for $48.21; on June 4th, 2020, the stock is trading for $40.73. That’s 15.5% capital depreciation over 5 years, or just over 3% per year, which is bad news.
Why is the stock performing so poorly?
Investors are concerned about two things: one, the fact that Altria’s investments in both JUUL and Cronos are costing the company money rather than generating income, and two, that society is progressively moving away from tobacco. They are worried that Altria is a dying company, unable to adapt to changing consumer demand.
They are partly right on both fronts: So far, both JUUL and Cronos are poor investments and out of the 34 million smokers in the US, it is estimated that “20 million U.S. adult smokers are seeking less harmful alternatives to cigarettes“.
Altria is not standing still. It is implementing a “10-year Vision” to lead the transition of adult smokers towards non-combustible products. For example, it is working to expand both IQOS, the first heat-not-burn product to receive FDA pre-market authorization and on!, an oral nicotine pouch. The success of these products is uncertain but it shows that Altria is serious about bucking the trend.
Why do I like this stock?
First, because despite all the negative hype, Altria remains a very profitable company:
- Q1 2020 Revenues increased 14.9% from Q1 2019, to $5.04bn from $4.3bn.
- Q1 2020 Net Income increased 38.5% from Q1 2019, to $1.55bn from $1.12bn.
- Q1 2020 Free Cash Flow increased 36% from Q1 2019, to $3.07bn from $2.251bn.
These are not the metrics of a dying company.
Second, Altria’s dividend history is simply best in class: 54 quarterly dividend increases in 50 years, a current dividend yield of 8.5% and a 5-year growth rate of 10.40% are simply too good to turn down.
I think buying a few shares under $45 for the dividend income alone is a good deal. However, I’m hesitant to recommend buying the stock for more than that. If you feel that Altria’s 10-Year Plan will be successful, then you can consider buying all the way to $50.
The health effects of cigarette smoking are well known and most people will refuse to invest in tobacco stocks for this reason. I share this concern but I also realize that smoking is one of life’s small pleasures that will probably never be eradicated.
2 – JUNK FOOD
Americans spend more than $50bn on fast food and $14.5bn on sugary drinks every year.
There are plenty of stocks to choose from, but I like Domino’s Pizza (NYSE: DPZ). At $380+, it’s certainly expensive, but the company’s fundamentals justify it.
First and foremost, the franchise is incredibly popular and it controls roughly 35% of the pizza delivery market. Second, its finances are impressive: 2019 Revenues grew to $3.6bn from $2.4bn in 2016; 2019 Net Income increased to $400M from $214M in 2016; and 2019 Free Cash Flow increased to $411M from $228.7M in 2016.
The worrying aspect of the Balance Sheet is the $4.2bn of long term debt, which dwarfs the $1.3bn of total assets. As a result, total stockholder equity is NEGATIVE $3.3bn.
What’s going on?
Dominos Pizza is financing share buybacks and dividend payments by issuing debt. This is a potentially huge problem if cash flow ever dries up. The coronavirus crisis has shown that crisis can occur at any moment and highly leveraged companies then have to either beg Uncle Sam for a bailout or emit more debt just to cover their operating expenses.
Despite pursuing this questionable strategy, I believe Domino’s Pizza is well positioned to further strengthen its market dominance in the post coronavirus-world.
Traditional restaurants may suffer the long term consequences of social distancing, but Domino’s business model of specializing in delivery and digital infrastructure will be definite advantages in the coming years. Analyst Peter Saleh says that “We expect large pizza chains such as Domino’s and Papa John’s to continue to take share from small and independent operators […] brands such as Domino’s that have invested in their digital infrastructure have a lasting competitive advantage not only on sales but also within their cost structure.“.
Lastly, DPZ pays a small dividend. At $3.12 per year and under 1% yield, it won’t make you rich, but the 5 year dividend growth rate of 21% suggests that payout will continue increased in coming years. In April, Domino’s declared a $0.78 quarterly dividend, in line with previous, and there is zero indication the dividend is threatened in any way.
For these reasons, I believe DPZ will be able to offset the coronavirus damage to its business, compared to traditional restaurants, less innovative fast food chains, and other franchises with a poor hygiene history.
Much like smoking, junk food can be very addicting and have severe consequences for your health. The prevalence of obesity is on the rise and many people will be unwilling to invest in junk food stocks because they see it as encouraging unhealthy eating. This is true, but I also recognize that like many sin products, junk food should be consumed responsibly, and that ultimately people have the freedom of choosing their what they eat.
3 – ENERGY DRINKS
Energy drinks are incredibly popular the global market is estimated to be worth $53bn.
But do they belong in the sin stocks category?
Consider this: A typical 16 fl.oz can of has 160mg of caffeine (which is equivalent to 1.5 cups of coffee), 54 grams of sugar (which represents roughly 13.5 tablespoons) and 200% the average daily recommended dose of B vitamins. Consuming these doses individually could almost be considered reasonable, but consuming them all at once is definitely bad for you.
Monster Beverage Corp (Nasdaq: MNST), partly owned by Coca-Cola, is one of the largest energy drink producers in the world. It owns very popular brands such as NOS, Burn, Predator, Relentless and Full Throttle.
What I like most about Monster is its healthy Balance Sheet: 2016-2019 Revenues grew at an average annual rate of 11.26%, to $4.2bn from $3bn, normalized EBITDA grew to $1.4bn from $1.1bn and Free Cash Flow almost doubled, going from $596M to $1bn. This is incredible growth.
In addition, Monster only has $1bn of liabilities, of which 2/3 are account payables; its long term debt are barely over $300M. Based on its latest quarterly report, Monster’s total net debt is only $30.3M. In the current environment of extreme debt ratios, this is surprisingly refreshing (no pun intended).
The question is has Monster maxed its growth potential? Some say that specializing in the energy drink niche can only take a company so far and that Monster may have reached its peak market penetration.
I don’t agree.
A 2019 report conducted by Allied Market Research claims that the energy drink market will grow to $86bn by 2026, from $53bn in 2018. In particular, the Asia-Pacific region is expected to post 7.3% CAGR from 2019-2016. This is good news for Monster, who holds a 33.9% market share, and the brand power to capitalize on the growth of this market.
The drawback to investing in Monster is the lack of dividend. I’m not too worried about this for now because it’s still a growth stock. Either they become so big they’ll pay one eventually or Coca-Cola will buy them out entirely and perhaps retire the stock, meaning you’ll get some Dividend Aristocrat KO stock in exchange. Win-win.
4 – ALCOHOL
Beer is one of the most popular drinks in the world.
Kirin Beer University (yes, it exists), has been tracking beer data since 1975. Their 2019 annual report report reveals that in 2018, global beer consumption “stood at approximately 188.79 million kiloters, up 0.8% from the previous year, which is equivalent to approximately 2.4 billion 633ml bottles“. That’s a lot of beer.
Anhauser-Busch (NYSE: BUD) is the undisputed beer leader in the U.S. Its family of brands includes household names like Budweiser, Bud Light, Stella Artois, Presidente, and Hoegaarden, ‘beyond-beer’ brands like KomBrewCha, HiBal Energy, and Bon & Viv Spiked Seltzer, and craft beer brands Four Peaks, Goose Island, and Devil’s Backbone, among plenty of others.
In 2019, 6 of the 10 best-selling beers in the USA were manufactured by Anhauser. Those six brands alone gave the company a 30% share of the total beer market in the USA.
Unsurprisingly, this impressive portfolio generates fantastic financial returns: $50bn+ of annual revenues, 2019 Net Income of more than $9bn, 2019 EBITDA of $21.6bn, 2019 Free Cash Flow $8.2bn…The metrics are staggering.
The negative aspect of Anhauser’s Balance Sheet is the net debt of $93.7bn. However, given its huge assets of almost $240bn, the Net Debt Ratio is 0.396 and the Net Debt/Equity ratio is 1.23. If BUD can sustain its huge sales and cash flow, then honoring its debt payments should not be an issue. In 2019, for example, BUD simultaneously paid off $31bn of debt and paid $5bn of dividends.
Speaking of dividends, Anhauser’s annual payout of $1.44 will yield you a 2.6%. return. On April 14th, management announced that it was cutting the final 2019 dividend in half, to $0.50 per share from $1 per share. The reduced payout saved the company just over $1bn. This cut was necessary given that the coronavirus caused a 9.3% drop in volume in Q1 and an even worse 32% plunge in shipments in April.
While this cut was probably necessary to preserve liquidity, critics of the stock will rightly point out that BUD had already cut its dividend once well before the coronavirus: in 2018, following the acquision of SABMiller, BUD slashed the dividend by half in order to clean up its debt-laden balance sheet.
Short term, this is very painful for investors who rely on the dividend for immediate income. For long term investors, this should be viewed positively because it means the is company acknowledging its weaknesses and cleaning up its act to ensure it can sustain the dividend payment for a long time.
Given the company’s sheer size and brand portfolio, I expect post-coronavirus sales to pick up sooner rather than later. Once that happens, the company should pursue its strategy of paying off its debt to be in a position to start increasing the dividend within 18-24 months. Encouraging signs are already appearing, with Nielsen data revealing that total alcoholic beverage sales rose 35% Y/Y for the week ending May 9th, the third consecutive week of accelerating sales.
All in all, I think sub-$60 represents a reasonable entry. The popularity of beer is not going to wane anytime soon and I believe BUD’s strategy of reducing its leverage will be successful. Once that happens, the dividend will increase once again, to the delight of patient investors with low dollar cost average positions.
5 – CASINOS
In virtually every religion, gambling is considered a cardinal sin. While the Bible does not specifically condemn gambling, Mathew 6:24 proclaims that “No one can serve two masters. Either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve both God and Money”. I don’t think anyone can argue against the fact that gambling promotes the love of money to an extreme level.
Ironically, in America, a deeply religious country, gambling has its own place of worship: Las Vegas, aptly nicknamed “Sin City“. Built in the middle of the desert, Las Vegas boasts 136 casinos and plenty of other morally-dubious establishments. Obviously, the coronavirus forced them all to close and their stocks plummeted along with the overall market.
Casinos are reopening and gamblers are flocking there as if there had never been a crisis. Cautious tourists may wait a few months to see if a second wave breaks out before visiting, but if the virus is kept under control, I fully expect business to pick up where it left off within a year or two.
There are several interesting Casino stocks to pick from, but I choose Eldorado Resorts (Nasdaq: ERI) because of its impressive growth and stock performance. Granted, it’s located in Reno, not Las Vegas, but it’s a big, profitable casinos that customers seem to love.
Financial metrics are those of a promising growth stock: 2019 revenues of $2.5bn are up 180% from $892M in 2016, 2019 Net Income of $81M is up 285% from $21M in 2016 and 2019 Free Cash Flow of $122M is up 161% from $46.7M in 2016. The $3.8bn of long term debt is significant but not overly worrying given the company’s growth.
Unfortunately, the company doesn’t yet pay a dividend but if growth is sustained then buying under $50 may prove to be a wise long term investment.
6 – PRISONS
More than 2.3 million people are detained in US prisons. The problem is that federal prisons are operating at full or beyond full capacity so the government is relying on private prisons to house the surplus inmates. Today, roughly 8% of the total prison population, or approximately 121,000 people, are detained in private prisons across the country.
The GEO Group is a REIT who invests in private prisons and mental health facilities in North America, Australia, South Africa, and the United Kingdom. The company manages and/or owns 95,000 beds at 129 facilities and provided community supervision services for more than 210,000 offenders and pretrial defendants. In 2019, 64% of the company’s revenues were generated by agencies of the US federal government. This is a very safe revenue stream.
The big red flags are extreme leverage and poor stock performance: GEO’s Net Debt is $2.7bn, which gives it a horrible Net Debt/EBITDA ratio of 5.94. It’s true that REITs are often highly leveraged, but this is pretty extreme. The reassuring metrics are revenues and EBIT, which are increasing consistently, and Free Cash Flow, which is consistently above $70M.
The stock is trading at a 10-year low and capital depreciation is a real risk that potential investors should be aware of.
While the stock performance is appalling, GEO’s dividend is very attractive: the $1.92 annual payout represents a yield of 14%. The payout ratio is very high, more than 150% of Net Income, but the div/AFFO ratio is a more reasonable 86.8% ($57.7M of dividends paid out of AFFO of $66.5M of AFFO). I think GEO should focus on reducing leverage to reassure investors.
If the fundamentals are OK, why is the stock underperforming?
Like many private prison operators, GEO is under intense public scrutiny. Every single Democratic Party candidate for the 2020 presidency – bar Bloomberg – said the federal government should stop using private prisons. Understandably, long term investors are fleeing the stock out of fear the government will shut down GEO and similar institutions.
Perhaps GEO should hedge its risk by developing its rehabilitation programs in order to diversify its activities rather than focusing so heavily on incarceration. For now, rehabilitation only represents 25% of GEO’s services and the company should try to increase this share in coming years just to be on the safe side.
In sum, I only recommend buying this stock if you believe in GEO’s ability to fend of political pressure. I own a few shares of GEO and I’m quietly bullish, but I am paying special attention to the political climate and I will reevaluate my investment in due course.
7 – FIREARMS
Americans and guns. Name a more iconic duo.
The 2nd amendment guarantees the right to bear arms and to form citizen milicias in the unfortunate events of a foreign invasion or the emergence of a tyrannical government.
I was interested in purchasing some shares in a gun company for the heck of it and I’m sad to say I didn’t find a single exciting gun stock out there. However, since I have to choose one, I’m torn betweeen American Outdoor Brands (soon to be renamed Smith & Wesson Brands) (SWBI) and Sturm Ruger (RGR). Obviously, both companies are iconic in their own right and need no introduction. From subcompact pistols to AR-15s, they have all of your gun needs covered.
Why don’t I like these stocks?
My main objection is weak financial performance in recent years:
- Ruger’s 2016-2019 revenues decreased 38% from $664.3M to $410.5M in 2019 and its Net Income fell 63% from $87.4M to $32.2M.
- American Outdoor’s 2016-2019 revenues decreased 11.74% from $722.9M to $638M and its Net Income fell 80% from $145M to $28.7M.
These figures are far from reassuring and suggests these companies are in decline.
In my opinion, investing in firearm stocks is somewhat of a long term hedge against global instability. The coronavirus is causing a severe economic recession and the recent riots have caused a spike in all gun stock prices. If you believe the world economy and society at large are heading towards chaos, then this might be a wise investment. If, on the contrary, you think we are about to enter a new era of peace and prosperity, you should reconsider buying shares. For what it’s worth, Ruger’s CEO foresees rising demand in the coming quarters.
Out of the two stocks, only Ruger pays a dividend. Yes, it’s a modest 1.14% yield, yes the dividend has been reduced for the past 4 consecutive years, and yes, revenues are declining. But look on the bright side: The payout ratio is only 21% so if sales do pick up in the coming years then Ruger might increase its dividend again. Smith & Wesson doesn’t pay a dividend and the share price is cheaper.
If I had to choose, I’d go with Ruger simply because of the dividend. That said, the current price is a bit high for me so I would wait for a pullback to $60 under before pulling the trigger.
Guns are obviously a controversial topic and investing in firearms should not be taken lightly. Yes, guns are used in homicides and mass murders, but they are also used by ordinary citizens to protect their families from criminals. Whatever your position on the issues, you must recognize that weapons are tools that can be used for either good or evil.
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Disclaimer: This is not financial advice. Always do your own research before investing.