Backing unloved sin stocks beats shootin’ and pollutin’ – The Wall Street Journal

Who in their right mind would get a kick out of shooting at others or polluting our skies with coal burning power stations? Perhaps someone who fits into one of the categories on the list of mental disorders, (DSM 5). Not that there's any shortage of such people in political leadership. In this analysis of specific stocks by the Wall Street Journal, it emerges that 'feel-good' items, even those that threaten one's health, outperform products that can cause instant death (guns) or threaten the survival of humankind as a species (coal). The negative-risk-narrative of guns and coal makes them a less-safe hedge bet than alcohol and tobacco which have been the best performers in both the USA and the UK since the early 20th century. Herein lies the paradox. The former deadly duo is probably undervalued with wild swings as markets are impacted by technology and politics. So, if you're a smart, down and dirty, shootin' cowboy, unbothered by moral ponderings, you can make a lot of money. While the rest of us take our simpler pleasures, smoking and drinking – or doing neither but trading in these addiction-forming habits. Could voting politicians out be easier than kicking a habit? – Chris Bateman.Guns and coal offer the sin of tobacco stocks, but not the quality.By James Mackintosh(The Wall Street Journal) – The stock market has fallen out of love with guns and coal, and companies are having to choose: Quit the sullied industries, or follow the example of Big Tobacco and specialise in being unloved. ___STEADY_PAYWALL___.In the US, the backlash against civilian firearms last month led American Outdoor Brands to announce it would split from Smith & Wesson, following the exit from gun-making of Vista Outdoor owner of brands including Camp Chef barbecues, Camelbak water carriers and Giro cycling gear.In environmentally minded Europe, coal is being dumped as companies try to clean up their acts, with mines and power stations sold.Investors who have been selling stock, engaging with directors or withholding loans to try to change company behaviour might regard this process of sorting in the stock market as their doing."We think companies are being driven to think very carefully about the dirty components of their business and are increasingly going down the route of spinning them off," said Eoin Murray, head of investment at Hermes.Leaving aside the moral considerations, what's an investor to do?The answer comes down to why guns and coal are being split out of companies. One explanation is that they are reviled for ethical reasons, in which case some investors are selling good businesses on the cheap. Those who don't care about or agree with the ethics can pick them up for less than they're worth.Another is that they've become more risky – they are highly exposed to political winds and public mores – and hiving them off into a separate vehicle is a way to hand that risk to investors willing to bear it in exchange for higher dividends. Adjust for risk, and returns might not be any higher.WORLDVIEW: BAT cuts jobs, vaping drama, and the end of sin stocksSouth32 is the latest miner to exit thermal coal, used for power stations, with the sale last month of its South African mines to a local privately owned miner. Its exit will tick a box for many investors and environmental funds, which have followed the lead of Norway's sovereign-wealth fund in refusing to own companies that mine or use thermal coal.But as with the gunmakers, the economics of coal have shifted and the long-term outlook is uncertain, at best. The initial response of the firearms producers to a future of possible decline was to diversify, using the profits from making guns to finance expansion in outdoor equipment and hunting accessories in the hope these operations could grow faster.The global miners did something similar, with many, including South32, announcing they would open no new thermal coal mines; profits from coal were ploughed back into producing other commodities instead.It isn't obvious that this strategy works. There have been wild swings in demand for firearms and coal in the past few years as politics and technology impinged on the business.Instead of diversifying, perhaps businesses with such high uncertainty need investors happy to hold on through the volatility in return for a fat dividend. The uncontroversial operations offering expansion may be better off with owners happier with the risks that come with chasing growth than with political and regulatory dangers.These are the sort of ordinary capital structure considerations that have driven a wave of spinoffs listing in Europe this year, led by the internet assets of South Africa's Naspers, including its stake in China's Tencent, and Novartis's Alcon eye care business. Moral issues played no part in justifying these splits, which this year in Europe were by far the most valuable in data back to 1995, according to Dealogic.In the case of coal and guns, the economics dovetails with the customer, political and investor pressure, just as it did with the tobacco giants. Most of the tobacco majors used to be conglomerates; Altria owned Kraft Foods while Imperial Tobacco (now Imperial Brands ) ran hotels and made potato chips, among other things. When courts and regulators turned against cigarettes, the core business remained highly profitable but its future was much less certain. It was better to avoid staining the other brands with nicotine ownership and its legal risks.Read also: First it was tobacco – now big food is in the firing lineIf companies are right to think they need a different capital structure for guns and coal because of the risks of these businesses, then they might be right or wrong, but there's no particular reason to expect a bargain. But if they're being dumped because lots of investors don't want to own them, or are pushing for their sale, they might well be sold at less than their true value, giving them a better chance of beating the market.Here the comparison is again with tobacco, as well as alcohol. According to academics Elroy Dimson, Paul Marsh and Mike Staunton, these "sin stocks" have been the best performers since early in the 20th century in both the UK and US (US alcohol stocks only since prohibition ended, of course). If the thought of selling addictive and damaging drugs made some investors feel queasy, the stocks should be consistently underpriced, and so able to outperform as they did.The trouble is that the outperformance of alcohol and tobacco might have been nothing to do with being sinful. Selling addictive products that make people feel good is one of the best businesses to be in, through good economic times and bad. Because it doesn't offer the glamor of new technologies or rapid growth, it has tended to be underpriced, along with other so-called "quality" stocks, and so could outperform.Unfortunately for coal and gun companies, they offer only the sin, not the quality.Write to James Mackintosh at James.Mackintosh@wsj.com

Backing unloved sin stocks beats shootin’ and pollutin’ – The Wall Street Journal

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