What it means
Investopedia says sin stock sectors usually include alcohol, tobacco, gambling, sex-related industries and weapons makers. The list changes by region and by person.
Brewing is an old tradition in much of the world, so not everyone treats alcohol as a sin, and views on military contractors differ. The case for owning them starts with demand.
Investopedia notes that demand for many of these products is relatively inelastic, so sales hold up better in a recession. Social and regulatory limits can also keep new competitors out, which supports margins.
There is academic support for a price effect. Hong and Kacperczyk, in the Journal of Financial Economics, found that sin stocks are less held by norm-constrained institutions such as pension plans, and get less analyst coverage.
They also found higher expected returns than comparable stocks, which they link to neglect by those investors and to greater litigation risk. The risks are real.
Governments may raise taxes on these products, restrict advertising, or ban them, and Investopedia calls the political risk far greater than for most stocks, pointing to the way public opinion can lead to prohibition. There is also a reputational risk, since a company can lose customers, lenders or access to funds if public attitudes turn, and litigation can be costly, as the academic study notes.
Sin stocks are different from a sin tax, which is a levy on the product. The stock is the share of the company that sells it, so a tax hits the company through its costs and sales volume.
Investors who use screens in an ethical fund will usually exclude these shares, and that can lower diversification slightly. The label is not a quality rating.
A sin stock can be overvalued, in debt or in decline like any other share. Returns in the past do not guarantee returns in future, and rules and tastes differ across countries.
In practice
Real-world examples.
Example
A fictional investor puts $100,000 into a portfolio that earns 8% a year and compares it with a screened portfolio earning 7%. After 20 years the first is worth about $466,096 and the second about $386,968. The gap of $79,128 is the possible cost of the screen, if the return gap persists.
Example
A fictional tobacco company earns $5.00 a share and trades at $80, a price-to-earnings ratio of 16. A new tax cuts earnings by 20% to $4.00. At the same ratio the price would be $64 ($4.00 x 16), a fall of 20%.
Example
A fictional investor holds $60,000 of a gambling company that pays a 5% dividend yield. The dividend income is $3,000 a year. If the licence is withdrawn and the dividend stops, that income is gone along with part of the share price.
Formula
Calculation
Future value = Present value x (1 + r) ^ n. With $100,000 x 1.08 ^ 20 = $466,096 and $100,000 x 1.07 ^ 20 = $386,968.
Price after tax shock = New earnings x P/E ratio. With $4.00 x 16 = $64.
Dividend income = Holding x Dividend yield. With $60,000 x 5% = $3,000.
Portfolio impact = Position weight x Share price change. A 3% position that falls 10% moves the whole portfolio by 3% x 10% = 0.3%, so a $200,000 portfolio loses 0.3% x $200,000 = $600. The same 10% fall in a 30% position would cost 30% x 10% = 3%, or $6,000, which is why position size is the main control on this risk.Case study
Seen in the real world.
This case study is fictional and illustrative. Lena, 41, in Berlin, owns a global index fund and wonders whether to add a brewing stock. She sees that the company pays a steady dividend and sells in recessions. She also reads about the political risk and the chance of higher alcohol taxes.
She decides how she feels about the product, since she does not want to own something she disagrees with. She decides to limit it to 3% of her portfolio. She will review the holding each year and read any news on taxes. A year later a tax rise cuts the share price by 10%.
Because the position is small, her portfolio falls only 0.3%, and she keeps to her plan. In dollar terms, her portfolio is $200,000, so the brewing position is 3% x $200,000 = $6,000. The 10% fall cost her $600, which her other holdings more than offset in the same year. She also notes the dividend of 4% on $6,000, or $240, still arrived, and she reviews the holding again at year end instead of reacting to the headline.
Watch out
Common mistakes.
- Assuming sin stocks are safe because the products are habit-forming, when taxes and bans can hit earnings.
- Treating the sin label as objective when it depends on culture and personal values.
- Buying only for the dividend without checking debt, litigation and the future of the industry.
Questions
People also ask.
What is a sin stock?
It is a share in a company whose business is widely seen as morally questionable, such as tobacco, alcohol or gambling.
Do sin stocks earn higher returns?
Some research found higher expected returns than comparable stocks. It does not guarantee future results, and the risks are real.
Is a sin stock the same as a sin tax?
No. A sin tax is a levy on a product, while a sin stock is a share in the company that sells it.
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