Vice shares often have good growth and dividend prospects.
Tobacco and alcohol, delicious fathers of abiding friendships and fertile reveries – Luis Buñuel
If you're looking to buy shares in a stable business which has good growth prospects and pays a reasonable dividend, and you don't consider yourself to be an ethical investor, you could do far worse than to have a look at the multinational alcohol and tobacco manufacturers.
These firms' products are sold all over the world to hundreds of millions of consumers, so they are not overly dependent upon any one market or customer. Thus they are able to ride out local and regional recessions which would play havoc with the finances of smaller companies.
So when the financial world imploded during 2008-2009, dragging down most companies' earnings, the big alcohol and tobacco firms' profits continued to rise. If they can do this during bad times, just imagine what they can do during a boom!
Recession, what recession?
The very nature of these firms' products means that people keep coming back for more, often at the expense of other goods. Tobacco is an extremely addictive product which makes the tobacco business very resistant to economic downturns. When times are hard, many smokers will choose to cut back on other things, in order to keep getting their nicotine fix.
Whilst some smokers switch to cheaper brands when times are hard, they often end up smoking cigarettes which are made by the same company so the same firm still gets their money! Most of the cigarettes sold in the UK are made by just four companies; the two British firms, British American Tobacco (LSE: BATS) and Imperial Tobacco (LSE: IMT) and their main overseas competitors Altria Group and R.J. Reynolds.
Strong brands
Britain has two major multinational alcohol producers, the spirits group Diageo (LSE: DGE) and the brewer SAB Miller (LSE: SAB). Both firms have a very strong presence in their markets around the world but don't dominate them to quite the same extent as the tobacco companies because of the presence of many local competitors.
It's quite surprising to discover the number of brands which are owned by these four companies. For example, the iconic French brands Gauloises and Gitanes are both owned by Imperial Tobacco, Diageo owns Baileys Irish Cream and Smirnoff vodka whilst SAB Miller is the name behind Grolsch and, of course, the Miller range of beers.
A look at the numbers
My colleague at Fool HQ, Todd Wenning, has written about three of these companies, paying particular attention to their dividends, in his very popular series "dividend report card". You can follow these links to see his articles on British American Tobacco, Diageo and Imperial Tobacco.
I've summarised the key earnings and dividend data for four firms in the table below using the most recent profits forecasts to calculate a prospective price-earnings ratio. Since SAB Miller's accounts are in US dollars, I've used a conversion rate of $1.59 to the pound.
| Company | Price-Earnings
ratio
(prospective) | Dividend
yield
(historic) |
|---|
| British American Tobacco | 13.5 | 4.2% |
| Imperial Tobacco | 10.0 | 4.4% |
| Diageo | 15.5 | 3.1% |
| SAB Miller | 18.7 | 2.0% |
Luxury and inferior goods
There are several reasons why the tobacco multinationals generally trade at a lower P/E ratio than the alcohol producers. Tobacco is seriously detrimental to people's health and life expectancy, so governments in the developed world have cracked down upon the sale of tobacco using massive taxes and legal restrictions.
This has caused sales to fall, so the tobacco multinationals have responded by expanding into the developing nations where their markets are still growing strongly.
Another reason is that tobacco often behaves as what economists call an "inferior good." Note that "inferior" isn't a reflection on the quality of the product; inferior goods are products for which consumer demand decreases as income increases.
In contrast, alcohol is a luxury good. Again this isn't a reflection upon the quality of the merchandise; when a consumer's income grows they typically spend a far greater proportion of their income upon luxury goods.
So as incomes around the world continue to rise, over time humanity's alcohol consumption should increase whilst its tobacco consumption should in turn decrease.
But tobacco sales aren't going to fall seriously for many years to come. The developing world's markets are simply too large for that to happen.
The future
Whilst alcohol is detrimental to people's health, if consumed in very large quantities, in the developed world it doesn't possess the same stigma as tobacco. Even though the smoking ban has hit the pub trade, most people who no longer go to the pub will have switched to drinking at home so sales of alcohol should still continue to rise.
But investors in alcohol companies do bear the risk that that politicians will one day crack down upon the sale of alcohol, just as they have done to tobacco.
Whilst it's not beyond the boundaries of possibility that some form of prohibition might be introduced, anyone who thinks that alcohol prohibition is a good idea should read up on how prohibition in the United States had very little effect whilst empowering organised crime. Or why not wait until next month when British Sky Broadcasting (LSE: BSY) starts showing HBO's new series about prohibition, "Boardwalk Empire."
More from Tony Luckett:
> Tony owns shares in Diageo.
