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business newsWhy Good Investors Like "Bad" Stocks
By
Charles Sizemore
Aug 31, 2010 3:15 pm
Companies involved with alcohol, tobacco, gaming, weapons, and adult entertainment historically make good investments because social stigmas depress their prices, inviting investors with no such moral qualms.
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Not all sin stocks are created equally, of course. As Warren Buffett likes to say, a good investment needs “moats” around the business. By “moats,” Buffett is speaking of durable competitive advantages that rival firms have difficulty replicating. Given the complex legal and tax environment in which sin stocks operate, most do have fairly substantial moats. One notable exception is the adult entertainment industry. Much like Internet file sharing wrecked the business model of the music industry, free pornographic sites have absolutely destroyed the economics of the adult media business. It’s hard to compete with “free.”
Consider Playboy Enterprises (PLA). Hugh Hefner’s creation has struggled for the past decade. In a June press release the company effectively gave up on selling magazines, instead planning to “transition Playboy to a brand management company,” which presumably means licensing T-shirts and other memorabilia with the Playboy bunny logo. We’ll see how that works out for ol’ Hef. There's no doubt quite a bit of marketability in the brand, but this doesn't change the underlying economics of the industry, which is likely in terminal decline.
Somewhat ironically, Hugh Hefner himself is a brand every bit as iconic as the bunny logo. He's also 84 years old and, alas, not immortal. One can’t help but wonder what the Playboy brand is really worth without its founder, whose personality defines the brand. Given that Playboy’s value to investors lies almost entirely in its intangible brand assets, this particular vice stock is probably best avoided for anything other than a short-term trade.
Princeton professor Harrison Hong and University of British Colombia professor Marcin Kacperczyk have found through empirical testing that sin stocks do indeed behave like value stocks and have soundly beaten the market over time. As Hong and Kacperczyk explain:Importantly, we find that even after accounting the loadings of the sin portfolio on well-known determinants of expected returns such as the market, size, past return, and market-to-book, a value-weighted portfolio of sin stocks significantly outperforms the market by approximately 76 basis points per month and the alpha is statistically significant at the 1% level of significance.
Given Hong and Kacperczyk’s findings, it should come as no shock that Altria (MO) is the most profitable stock investment in US history. Both Altria and its spinoff, Philip Morris International (PM), are recommendations of the Sizemore Investment Letter.
Many institutional investors, such as pension funds, university endowments, and charitable foundations, aren't permitted to invest in vice stocks or choose not to in order to avoid the headache. Their loss is our gain.
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Positions in MO and PM
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