A first look at a Fool's demonstration portfolio.
If you're looking to invest in companies who should be able to grow their profits even in today's uncertain times, you could do a lot worse than to consider those that are involved in what some people call sinful activities: alcohol, defence, gambling and tobacco.
Today I'm setting up a demonstration portfolio, which will invest about £20,000 in companies that operate in these sectors. I plan to review it on a quarterly basis and there will be no changes to it in between these dates.
Booze and ciggies in all seasons
Sales of alcohol and tobacco tend to remain steady during an economic downturn because people still drink and smoke when times are hard. Smokers find that it's especially difficult to cut back because they are addicted.
This strategy of investing by picking out preferred sectors of the stock market is one which I've followed for many years. Alcohol is one of my favourites, along with consumer goods, because of their defensive qualities and exposure to the emerging market nations. I would also have chosen tobacco as a place to invest, were it not for the fact that I won't touch it because of the effect that it has upon people's health.
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Gambling and defence are less resilient
Recent years have shown that gambling isn't as recession-proof as it once was, and the high-street bookmakers like Ladbrokes (LSE: LAD) and William Hill (LSE: WHL) have seen the internet gambling companies take a share of their markets. The industry is also under pressure from governments who are trying to push punters towards their own national lotteries, which offer much poorer value, in order to boost their tax take.
The demand for defence has declined since the end of the Cold War, and budgets are coming under further pressure nowadays because governments are trying to cut public spending. However, when war -- or even a bit of sabre-rattling -- breaks out, this will produce a lot of new equipment orders (even in a recession), and as a result the defence industry tends to be non-cyclical.
Consequently, the portfolio will be biased towards alcohol and tobacco, with roughly 40% in each sector, as I am more cautious about the prospects for defence and gambling.
The oldest industry
According to many historians the first industry was brewing, though agriculture soon followed when the hunter-gatherer tribes of Mesopotamia realised that the best way to ensure a reliable supply of the grains needed to make beer was to farm crops.
In the last few years, global alcohol consumption has risen, though consumers in the developed world have tended to cut back on beer and instead drink more spirits and wines. As there isn't a large British publically quoted wine company, 40% of the global sin portfolio is split between the world's largest distiller, Diageo (LSE: DGE), and brewing giant SABMiller (LSE: SAB).
Governments love and hate tobacco
Governments in the developed world are trying to cut tobacco consumption, because of the healthcare costs that smoking imposes on society. They are doing this by consistently raising tobacco taxes and restricting its sale, though they'd be horrified if everyone quit, as this would blow a massive hole in their finances.
A good example of how sales are restricted is the law that makes it illegal to smoke inside a public building, while the push towards plain packaging and other advertising restrictions is a less-than-subtle attempt to destroy some of the value of the top tobacco brands.
However, sales of tobacco in the developing world continue to grow strongly, and if you're comfortable with profiting from this then the two British giants, British American Tobacco (LSE: BATS) and Imperial Tobacco (LSE: IMT), deserve consideration. Roughly 20% of the sin portfolio is going into each of these companies.
You bet
As mentioned earlier, the last few years have shown that gambling is only 'recession-resistant' rather than 'recession-proof' as gamblers cut their spending. Consequently, I'm only putting 10% of the sin portfolio into gambling, and this is going into a company that doesn't rely too heavily upon high-street bookmaking shops. It's Rank Group (LSE: RNK), whose main businesses are the Mecca Bingo halls and Grosvenor casinos.
Planes, Guns and Tanks
The fourth sin category is defence, an industry that many people dislike because many of its products maim and kill people. Some go as far as to argue that that the industry deliberately hypes threats in order to support the "Military-industrial complex".
The final 10% of the global sin portfolio is going into BAE Systems (LSE: BA), which is Britain's largest defence company, whose biggest customers by a long way are the American and British governments. BAE has interests in pretty much every part of the defence industry as well as substantial civilian aerospace interests to provide some diversification.
Show me the money
The key figures for all six companies are summarised in the table below. Please note that the share price quoted in this case is the offer price; the price that you would pay to buy the shares.
| Company | Share price | Historic P/E | Dividend | Yield |
|---|
| BAE Systems | 297.4p | 8.0 | 18.8p | 6.3% |
| British American Tobacco | 3,351p | 17.1 | 126.5p | 3.8% |
| Diageo | 1,651.5p | 19.8 | 41.5p | 2.5% |
| Imperial Tobacco | 2,657p | 14.1 | 98.7p | 3.7% |
| Rank Group | 119.5p | 11.2 | 2.1p | 1.8% |
| SAB Miller | 2,629.5p | 19.0* | 58.7p* | 2.2% |
* based on the current pound-US dollar exchange rate
The next table is arranged in order of share price performance over 10 years. As you can see, the alcohol and tobacco companies that I've chosen have trounced the FTSE 100 (UKX) index, which in turn has outperformed both the defence and gambling companies.
| Company | Five-year growth | Ten-year growth |
|---|
| SAB Miller | 107.2% | 413.3% |
| British American Tobacco | 99.1% | 368.8% |
| Imperial Tobacco | 14.9% | 129.1% |
| Diageo | 60.3% | 104.9% |
| FTSE100 index | -15.9% | 21.9% |
| BAE Systems | -27.1% | -11.9% |
| Rank Group | -34.7% | -68.0% |
The final table shows the global sin portfolio. Everything has been 'bought' at the offer price at the time when the market closed yesterday evening, through an online stockbroker who charges £10 a trade, allowing for stamp duty at ½% and the total cost is rounded off to the nearest pound.
| Company | Offer price | Shares bought | Cost |
|---|
| BAE Systems | 297.4p | 680 | £2,042 |
| British American Tobacco | 3,351p | 120 | £4,051 |
| Diageo | 1,651.5p | 240 | £3,993 |
| Imperial Tobacco | 2,657p | 150 | £4,015 |
| Rank Group | 119.5p | 1,660 | £2,003 |
| SAB Miller | 2,629.5p | 150 | £3,973 |
| | | Total | £20,077 |
The current yield on the global sin portfolio is approximately 3¼%. I'll be checking back in three months time, when I have reasonable hopes that it will have beaten the FTSE 100 which for the record stands at 5,627.3 as I type this.
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> Tony owns shares in Diageo and SABMiller but he doesn't own shares in any of the other companies mentioned in this article.
