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Should you abstain from sin stocks?
The convention is that vice -- booze, adult entertainment, gambling -- does well in soft economies as people try to escape their worries. Fact is, these volatile stocks must be picked carefully.
By Michael Brush
When times are tough, people might drink a bit more, smoke a bit more, maybe even gamble a bit more. That would mean that stocks of companies that market beer and booze, tobacco and even sex should move against the market, right?
Wrong.
It may be true that sex, drugs and rock n' roll have been around a long time in one form or another and wont be going away any time soon. And business at companies like Playboy Enterprises (PLA, news, msgs) British American Tobacco (BTI, news, msgs), Anheuser-Busch (BUD, news, msgs) or Harrahs Entertainment (HET, news, msgs), might even pick up in the uncertain economic times ahead as more people look for escape, as proponents of vice investing are betting.
But the reality is that investing in sin is no sure bet. In fact, the Vice Fund (VICEX), the Dallas fund that invests unabashedly in gambling, alcohol, tobacco and defense stocks, has dropped more than 10% since its launch last summer. And some areas, such as gaming and tobacco, face higher risk as states view them as easy targets for tax revenue to plug budget shortfalls.
Still, these setbacks may only be temporary. And for those who have no moral qualms, there wont be a shortage of fresh ways to try to profit from vice. The Daily Planet, a brothel in Melbourne, Australia, for example, expects to go public this spring. Next February, the publisher John Wiley & Sons hopes to start profiting from a guide to investing in vice. Written by Caroline Waxler, the books working title: "Stocking Up on Sin: How to Crush the Market with Vice-Based Investing."
Heres a look at the world of vice stocks.
The seven deadly sins
First, its hard to find companies that profit from a broad range of activities that one might call sin. Pride and envy? No obvious plays there.
Sloth, gluttony, anger and greed? Well, there arent any real pure plays, but some companies that might be candidates include: Video game maker Electronic Arts (ERTS, news, msgs), Krispy Kreme Doughnuts (KKD, news, msgs), World Wrestling Entertainment (WWE, news, msgs), Pre-Paid Legal Services (PPD, news, msgs) and some Wall Street brokerages.
Lust, however, is another matter. While most of the estimated $56 billion worldwide adult entertainment industry is in private hands, there are actually quite a few publicly traded sex plays listed on U.S. stock exchanges.
For example, the Barcelona-based Private Media Group (PRVT, news, msgs), which distributes steamy films and pictures, trades on Nasdaq. Investors looking to get into topless bars can buy shares in Rick's Cabaret International (RICK, news, msgs). It runs strip joints in Texas and Minnesota, as well as erotic Web sites. The Boulder, Colo.-based New Frontier Media (NOOF, news, msgs), offers investors a piece of the action in pornographic films via adult cable TV and other systems. And of course, Hugh Hefners magazine that launched the modern era of erotica is now run by the public company Playboy Enterprises.
No profits in sex
But all of these stocks have the same problem: All have been terrible investments in the past two years. And that was a time when people were supposed to be turning to vice more often because of economic woes.
Shares of Private Media Group, which even made the Forbes list of the top 20 small companies around the world for 2002, have plummeted to $1.50 from $10 since early 2002. Shares in New Frontier Media and Playboy have been sliced in half in about the same time frame. Ricks, in fact, peaked at $11.50 in mid-1996 -- not long after its 1995 initial public offering. Its now trading at around $1.30.
The companies have been hit hard by growing competition in Internet porn and related adult sites, which have hurt revenue growth and margins in that space. One could argue New Frontier Media is competing against itself: It also operates a dozen subscription Web sites and licenses adult content to 1,300 others.
The companies also suffering from a slowdown in business travel, which has depressed the number of road warriors who might view adult-entertainment fare in hotel rooms or visit topless bars. Playboy, now 50, is struggling with anemic subscription growth and competing magazines such as Maxim, Stuff and FHM, which do a better job at capturing the imagination of young men.
Even if the underlying fundamentals at listed adult-entertainment companies were better, there would be another problem with these stocks. Trading volume is so small, it is difficult for professional money managers to build a serious position. The same goes for The Daily Planet, that soon-to-be listed Australian brothel, which asks potential investors to think of its lavish brothels -- complete with indoor pools -- as Melbourne's only six-star hotel allowing sexual services on site. (Prostitution was legalized in Melbourne and the rest of Australias Victoria state in 1985.)
In theory, we would snap these companies up, says Dan Ahrens, who runs Vice Fund. But, he adds, These companies are too small to trade in volume. There are no large corporations that seem to be growing in the adult entertainment industry. So we just ignore it.
A broader slump in sin
Setbacks for sin-oriented investors, however, reach beyond the sex industry. Over the past two years, a closed-end fund trafficking in the sin space, Morgan Funshares (MFUN), has traded roughly in line with the S&P 500, turning in only slightly better results. Casino stocks generally have been weak all year. And, of course, Ahrens own Vice fund has done worse than the broader indices since it was launched last summer.
To Matt Patsky, a portfolio manager at the politically correct Winslow Green Growth Fund (WGGFX), none of this is a surprise. If investing in sin means investing in high-fat foods, tobacco and liquor, we know that the trend line is not good for them, he says. His funds policy of paying close attention to potential legal liability -- one take on social responsibility -- has kept it out of troubled tobacco stocks, for example.
Just a temporary setback
The vicar of vice, however, remains unfazed. Anything like that can happen in the short term, says Ahrens. He thinks vice stocks are just suffering from temporary set backs, and theyll revert to their old strength soon enough. In the five years ending June 30, 2002, gaming shares advanced 116% and alcohol-related stocks were up 63% -- compared to a modest 12% gain for the Standard & Poors 500 index. Despite all their legal troubles, tobacco companies moved ahead 8% in the same time frame. We are very confident these sectors will perform long term.
He may have a point. Gaming stocks, for example, almost 25% of his sin portfolio, have been hammered of late, in part, by concerns that states will overtax casinos to plug budget shortfalls. More likely, lawmakers will realize that doing so will drive casinos out of their states, costing too much in lost tax revenue. (Other problems: the travel downturn related to the Sept. 11, 2001, terror attacks and the Iraq war.)
Tobacco stocks, meanwhile, look cheap to many analysts because fears about potential legal problems appear overblown.
Weakness in gaming and tobacco sectors now just makes us all the more bullish in the long term. These sectors are at great valuations right now, says Ahrens. With that in mind, heres a brief look at Ahrens game book. - The buzz on alcohol: You cant call this a fast growth industry, but we think it is absolutely embedded in our culture, and that is what makes it more recession-proof than any other industry, says Ahrens. He has a big position in Anheuser-Busch because of its record of taking market share and raising prices in the U.S. Its also expanding abroad through partnerships. The Vice Fund also holds Constellation Brands (STZ, news, msgs), the big beer, wine and liquor distributor. Its brands include Almaden, Inglenook and Simi wines, and it also imports such beverages as Corona beer and Fleishmann's gin. The company recently completed a merger with BLR Hardy, an Australian distributor. (Constellation Brands stock is up 621% over the last 10 years but down 12.7% in the last 12 months.)
That is what you see in alcohol more than anything else, the dominant players taking over the smaller players, Ahrens says. His fund also holds shares in U.K.-based Diageo (DEO, news, msgs), one of the largest producers of alcohol, which owns the Guinness and Smirnoff labels, among others. It trades here as an American Depositary Receipt (ADR). Some analysts warn that investors may abandon consumer staples companies like these in favor of growth names if the economy picks up.
- Tobacco's tale: While the percentage of people smoking in the U.S. may have declined, there is a huge worldwide market for tobacco that is growing, says Ahrens. In contrast, the risk of legal challenges is much more limited abroad. Thats why the Vice fund owns Imperial Tobacco Group (ITY, news, msgs) and British American Tobacco, which trade as ADRs. Ahrens also has a sizable position in Altria (MO, news, msgs), once better known as Phillip Morris. I believe that most of the litigation is in the past, he says. And the stock looks cheap, at 6.9 times 2003 earnings. The average forward price-earnings ratio over the past 25 years has been 10.
- Gaming's growth: In the long run, gaming stocks have two trends in their favor. The baby boomers are now solidly middle-aged. As a result, theyre moving into the time in life when they might frequent casinos more. Meanwhile, more states will be approving some form of gaming to generate additional tax revenue. Maryland, Pennsylvania, Indiana, Massachusetts, Kentucky and Ohio are considering adding slots or video lotteries to racetracks. Iowa and California are looking to expand gaming.
For exposure to this group, Ahrens likes Harrahs Entertainment, in part because its good at moving into new markets. Ahrens also owns Shuffle Master (SHFL, news, msgs), which makes automated card shufflers and other gaming machines. Everybody thinks the economy is bad, but its not bad in Las Vegas, and, as it continues to expand there, Shuffle Master gets a piece of the pie, says Ahrens.
- How defense stocks fit in: This group doesnt cater to a vice, but Ahrens buys them because most politically correct funds reject them. Long-term spending trends still look solid thanks to aggressive defense spending increases mapped out by President Bush. Ahrens likes Northrop Grumman (NOC, news, msgs), Lockheed Martin (LMT, news, msgs) and L-3 Communications (LLL, news, msgs), among others.
The morality of it all
Does Ahrens have any qualms about managing a sin fund? Not one bit. I am a big believer in personal freedoms, says Ahrens, who describes himself as a Catholic who enjoys the diversions of drink and gaming in moderation. Alcohol, tobacco, gaming, those are all legal pastimes, so we think it is outrageous to screen them out for some kind of moral or social reasons, he says.
The public response to his fund has been positive as well, he says. Indeed, conservative political leaders such as William Bennett, author of "The Book of Virtues," and Phyllis Schlafly declined to comment on Ahrens Vice fund.
At least one fund manager from across the aisle, however, takes issue with Ahrens approach. Im sorry that they exploit peoples weaknesses, says Bill Van Allen, a devout Christian who is president of the $8.4-million-asset Noah Fund, (NOAHX). We ought to pray for them to become Christians so they can recognize the error of their ways. His funds top holdings: Wal-Mart Stores (WMT, news, msgs), Microsoft (MSFT, news, msgs) and Intel (INTC, news, msgs). (Microsoft owns MSN Money.)
Theres more overlap between some Christian funds and the sin fund than you might think.
Like the Noah fund, the Ave Maria Catholic Values funds (AVEMX) screens out any companies linked to pornography, birth control and the anti-family practice of offering benefits to unmarried domestic partners, says Robert Schwartz of Schwartz Investment Trust, the Detroit firm that manages the $61-million-asset Catholic Values fund. But the fund, whose largest holding is H&R Block (HRB, news, msgs), can hold shares in alcohol, gaming and defense stocks, just like the Vice fund.
In the long run, says Morningstar mutual fund analyst Shannon Zimmerman, socially responsible funds slightly underperform their peers, as a group.
One problem has been that sometimes they screen out so many types of companies that they are too heavy on tech and financials, says Zimmerman. Ironically, thats left more than a few exposed to one of the seven deadly sins: greed that welled up at the likes of Enron (ENRNQ, news, msgs) and WorldCom (WCOEQ, news, msgs).
In contrast, companies like Anheuser-Busch are excellent corporate citizens, says Ahrens. To my knowledge there have been no allegations of cooking the books in these old-line, stable, conservative companies.
For a screen of brewer stock performance over the last year, click here.
For a screen of how casino stocks have performed, click here.
For a screen of tobacco stocks over the last year, click here.
For a screen of vintner and distiller stocks, click here.
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