Are ‘sin’ stocks worth another look?

So much attention is currently focused on ‘doing the right thing’ when it comes to investing. 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. This means attempting to construct a portfolio that only contains companies that tick a few ESG (Environmental, Social, and Governance) boxes and making superior gains.

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, where companies in industries such as tobacco, energy, defense, and gambling have seen shareholders desert them. However, could this be an opportunity for investors who care more about making above-average returns than ‘doing the right thing’?

What is a sin stock?

Sin stocks can be quite easy to identify. Typically, these include companies involved in tobacco, arms manufacturing (defense), gambling, alcohol, miners, and energy companies still using fossil fuels. That said, you could add drug companies, food manufacturers, and chemical manufacturers depending on your own set of values.

Other sin stocks include businesses that are heavy polluters or engage in poor labor practices. BP would seem to be an obvious example of the former, despite the greenwash that covers the oil giant’s website. Yet it could be argued that for as long as we rely on fossil fuels, 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. While high-profile tech companies such as Amazon and Uber can tick plenty of boxes for ethical investors but could also be considered sin stocks due to their poor record when it comes to the treatment of their employees.

It’s fair to say that one person’s ethically responsible company is another person’s sin stock, which makes matters 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.

How can you make money from sin stocks?

How is it possible to make money out of sin stocks? If investors continually shun them then surely they will always be undervalued. Well, 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 stopped 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 are set by governments. Most regrettably, wars and security threats will always be with us. Overall, there’s a solidity 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.

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 head to Google to find long lists of the top bad-boy companies, including brewers and tobacco companies, arms manufacturers, and gambling outfits. There is also a Vice ETF to help you get started. But as with any form of investing, make sure you do your homework and due diligence. Keep diversified, and don’t trade (especially on leverage) with money you can’t afford to lose.