While most businesses have to deal with intense competition or a lack of demand, the so-called ‘sin stocks’ have neither of these problems.
Sin stocks operate in certain industries that are deemed bad for society and are actively clamped-down on by governments. The added regulatory burden raises the barriers to entry and makes these industries more concentrated. Meanwhile, sin products, such as gambling, tobacco, and alcohol, are often so addictive that customers are willing to pay exorbitant prices to get their fix.
It’s a recipe for some truly robust profitability, which is why I dedicate a portion of my watch list to these sin industries. Here are some of my favourites from the sinner basket:
Diageo
Drinks giant Diageo (LSE: DGE) is not only my favourite sin stocks, but it’s also one of my favourite British companies. Not only has the company delivered 21 consecutive dividend increases over the years, it has also doubled investor capital over the past five years.
Diageo’s 2% dividend yield is nothing to boast about, but it might be the most robust payout on the FTSE 100 at the moment. The company’s payout ratio is a mere 54.5%, which means it has plenty of room left to reward shareholders in the future.
Speaking of the future, 20% of the company’s drink sales are already generated in Asia, which is the fastest growing market for alcoholic beverages in the world. I think Diageo’s underlying business model and portfolio of incredible brands is enough to cheer any long-term investor, which is why it’s the cornerstone of my investment watch list.
British American Tobacco
Smoking is notoriously addictive. Fortunately, the rate of smokers across the globe has plateaued in recent years. Unfortunately, a 2014 study found that over a billion people were still addicted to tobacco and were loyal to brands that were owned by a handful of multinational conglomerates.
One of the largest is FTSE 100 constituent British American Tobacco (LSE: BATS). The £70bn tobacco giant offers a 7% dividend yield. While the stock has had a rough run over the past five years, the company’s underlying revenue, profits, and dividend payouts have steadily increased.
Earnings per share cover the dividend by more than 30%, while net gearing remains relatively low at 68.63%. However, investors have punished the stock as younger smokers have turned to vaping and e-cigarette products in recent years. The stock’s price-to-earnings ratio has been sliced in half over the past five years.
That presents an opportunity for long-term income-seeking investors like me.
Other sins
Drink producers and tobacco giants aren’t the only sin stocks I’ve been watching. The potential legalisation of sports betting in the US has piqued my interest in gambling stocks like 888 Holdings, while the possibility of a sugar tax has me eyeing AG Barr.
Foolish takeaway
The unique mix of high barriers to entry and relentless demand make sin stocks worth a closer look, in my opinion.
