George Osborne’s tax on sugary drinks teaches investors three key lessons. The first is that any company in any sector, operating in any part of the world can be subject to a major event that hurts its profitability and share price.
This makes diversification all the more crucial for investors, since it means that when a company is subject to a profit warning or the introduction of a tax that could dent sales and/or margins, the investor’s portfolio value will not be overly affected by the subsequent decline in the company’s share price.
In other words, diversifying reduces company-specific risk and while buying more stocks is a good idea, buying companies that operate in different regions, different sectors and that offer different investment appeal also makes sense. This point has been emphasised by the new sugar tax, but also in recent times by the slowdown in China (which affected China-focused stocks) and the fall in the oil price.
Health risks
As well as highlighting the importance of diversification, the new sugar tax also teaches investors that consumers are becoming healthier. Although the sugar tax is forcing people to potentially drink less sugary drinks through higher prices (if the cost of the tax is passed on to consumers by drinks companies), there’s a general trend towards consumers becoming healthier by their own choice. For example, people are now more aware than ever of the negative impacts of tobacco, alcohol and certain food groups. This means that companies operating within those spaces may find sales growth more difficult to come by in the long run.
Investors may therefore be forced to demand a wider margin of safety when buying shares in a tobacco, beverage or other ‘unhealthy’ company. As such, a number of stocks that were once favourable investments may prove to be riskier than previously thought and offer fewer potential rewards than had been the case in the past.
Embrace change
In addition, the new sugar tax has taught investors that business is constantly changing and all companies must innovate in order to maintain sales growth. Although the sugar tax was something of a surprise to many people, the reality is that a number of food groups have been identified as contributing to current obesity rates. And while a number of companies have sought to innovate and change their ingredients in recent years, a number of products (such as sugary drinks) have continued to use the same recipes despite increasing public pressure to reform.
Investors now may wish to take a look at their holdings and determine whether their stocks are doing enough to keep up with a changing consumer, economic and regulatory landscape. This isn’t just with regard to food and drink items, but also fossil fuels as cleaner energy becomes increasingly prevalent, tobacco as reduced-risk products increase in popularity and a whole host of other industries where the landscape is constantly changing.
Clearly, with change comes opportunity. For investors who are willing to take a calculated risk on companies that have the capacity to innovate, there’s the potential to generate significant long-term gains.
