Perhaps the stress of the 2011 “mini bear market” has my nerves a little frayed, but I find myself thinking a little too much about booze these days.
As an investor, this is not necessarily a bad thing. Alcoholic beverage stocks have had a good run, and most have beaten the S&P 500 this year.
There is quite a bit to like about beer, wine, and spirits stocks. Like tobacco, firearms, gambling and adult entertainment, booze stocks fall into that stigmatized segment of the market known as “sin stocks.” They also happen to be fabulous long-term investments. (See “The Price of Sin.”)
Because of the social stigma of profiting as a purveyor of vice, many high-minded endowments, pension funds, and other large institutional investors are prohibited from investing in sin stocks, which tends to keep their price relatively low and their dividends relatively high. This means that sin stocks tend to have the characteristics of winning value stocks for those of us with no such moral qualms.
The proof is in the pudding. While there is no “Sin Index” for us to use for comparative purposes, the Vice Fund (VICEX) comes awfully close. The Vice Fund’s mandate is to invest primarily in tobacco, alcohol, gambling, and defense stocks, and over its life it has absolutely crushed the S&P 500 (see Figure 1).
Vice’s exposure to the gaming industry proved to be a disaster when the economy fell into a tailspin in 2008; had the fund avoided this sector and focused more heavily on booze and smokes, its returns would be off the charts. But even with the routing of the gaming industry, Vice’s 80 percent return since 2002 is double that of the S&P 500. It’s good to be bad.
Figure 1: Vice Fund vs. S&P 500
So, dear investor, with all of this as background, whadaya drinkin’? Beer, wine, or whiskey?
Today I’m going to offer up one stock for each. And while three stocks does not constitute a diversified portfolio, I recommend that investors make vice investing a major part of their research process.
In the spirit of World Series baseball, we’ll start with beer. In recent years, the global beer industry has become highly consolidated and is now dominated by just four major players: Anheuser-Busch InBev (NYSE:BUD), SAB Miller (OTCPK:SBMRY), Heineken (HINKY.PK), and Carlsberg (OTC:CGBWF). While a case can be made for any of these beer behemoths in a diversified portfolio, my recommendation is the Brazilian regional giant AmBev (ABV).
Ambev is owned by the much larger Anheuser-Busch InBev, but it trades separately on the NYSE as an ADR. The company has no net debt, and it absolutely mints money. Its return on equity for the trailing 12 months was an impressive 34 percent, and it's growing its earnings per share at a 20 percent per year clip. Not bad.
Ambev is also a great long-term play on the rise of the South American middle class. As Brazil, Peru and other rising Latin stars continue to develop into modern economies, companies that profit directly from the legions of new middle-class consumers should do quite well. And Ambev, with its dominant position, is poised to profit quite nicely.
Next on the list is wine. Unfortunately, our options are somewhat more limited here. Unlike the global brew business, wine is much more highly fragmented. The industry is atomized into untold numbers of small vineyards, many of which are privately owned and not available to stock market investors. Of the vineyards that do have stock market listings, many primarily trade outside of the United States or are very thinly traded.
Still, investors can consider Constellation Brands (NYSE:STZ). Constellation is not a pure play on wine, as it has some exposure to beer and liquor, but it is the largest wine company in the world.
In some ways, the demand story for wine is better than for beer, as wine should benefit from positive demographic trends. The Baby Boomers — the largest and richest generation in history — long ago passed the beer-swilling stage of their lives. They do, however, still enjoy a nice glass of wine with dinner. And Generation X and the much larger Echo Boomer generation have embraced wine at much younger ages than their forbearers. Perhaps it is because they are more health and body conscious (some would just say vain … I’m trying to be open-minded), wine is viewed as a less-fattening alternative to beer.
Constellation has had a rough year, seeing its profits shrink, but the stock is cheap at just 9 times forward earnings and it has a respectable return on equity of 26 percent. Constellation deserves a place in a diversified vice portfolio.
Finally, we get to the hard stuff. My favorite stock in the world of premium spirits is the British Diageo (NYSE:DEO), the owner of Johnny Walker scotch, Crown Royal Canadian whiskey, Smirnoff vodka, and Tanqueray gin, among many others. In addition to all of the best aspects of sin stocks, Diageo sits at the intersection of two other macro themes I’m following in The Sizemore Investment Letter.
As a seller of premium drinks, Diageo tends to sell to a higher-income consumer. As the “Occupy Wall Street” crowd has made abundantly clear, upper-income Americans and Europeans (and in this case I would include the top half of wage earners, not just the top 1% with which Occupy Wall Street appears to be obsessed) are doing just fine. The working classes are suffering; the professional and leisure classes are not. Whether we enjoy a robust economic recovery or sink back into recession, Diageo should do just fine.
Diageo is also a “backdoor” way to get access to the rise of the emerging market consumer. The company already gets a third of its sales from up-and-coming emerging markets in Asia, Latin America, the Middle East, and Africa, and this percentage will only increase with time. Diageo also pays a great (and rising) dividend of nearly 4 percent.
Whether your preference is beer, wine, or whiskey, consider adding some of these sin stocks to your portfolio. The returns should give plenty of cause for celebration.
Disclosure: I am long DEO.