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Sin stocks: Lacking in virtue, but big on gains

Special to The Globe and Mail

Investing in sin is good business, even if it gives some investors a case of ethical jitters. Just how good can be seen from the returns of the Vice Fund, a mutual fund based in Dallas, Tex., that invests in tobacco, arms and gambling companies.

For the 12 months ended Jan. 31, 2007, it produced a 22.8-per-cent return, beating the 14.5-per-cent return of the S&P 500 Total Return index in U.S. dollars, not to mention the 16.8-per-cent return posted by the Bloomfield Hills, Mich.-based Ave Maria Growth Fund, a portfolio intended to be invested in line with Catholic values.

In Canada, most of the funds sold by Ethical Funds, a Vancouver-based company, did not do as well as the Ave Maria portfolio, though the Ethical Global Equity Fund, spurred by the decline of the Canadian dollar, returned 19.8 per cent in the 12 months ended Jan. 31, 2007, the best gain of the company's 15 funds.

What constitutes a sin stock is a matter of personal opinion, said Jennifer Colson, at Ethical Funds. "We screen out tobacco, military weapons, handguns and nuclear energy, but we do not screen out distillers, brewers, wine makers or casinos."

In this two-part examination of the profits of sin, we'll look first at tobacco and alcoholic beverages, two industries based on old technology. Tomorrow, we'll look at newer technologies -- the casino and entertainment business, and weapons makers.

Tobacco is on every ethical investor's list of objectionable industries. However, government-imposed restrictions on marketing practices have reduced the ability of tobacco companies to advertise. That has raised margins, said Roger Dent, a portfolio manager at Mavrix Funds Management Inc. in Toronto. "It's also an industry that no one wants to enter, that has deeply established brands, and that has huge litigation risk."

Altria Group Inc. (MO-NYSE), owner of Philip Morris Inc., Kraft Foods Inc. and Miller Brewing Co., has seen its stock price double since late 2004, to a close of $84.42 (U.S.) yesterday. It is also a cash cow. Earnings per share rose at a compound average annual rate of 14.3 per cent for three years ended Dec. 31, 2006, with a 4-per-cent yield. An anticipated spinoff of Kraft adds to the present lustre of the company.

UST Inc. (UST -NYSE) has not done as well. A maker of chewing tobacco and cigars, its shares have risen to $55 from $40 since the beginning of 2006, even as sales have stagnated and earnings per share fell by 3 per cent for the year ended Dec. 31, 2006.

Rothmans Inc. (ROC-TSX) Canada's largest tobacco company, faces numerous provincial lawsuits for medical costs associated with smoking, Nevertheless, the company saw its sales rise by 1.7 per cent for the 12 months ended Dec. 31, 2006, even as earnings per share slumped by 2.7 per cent in the same period. Shares, supported by a 6-per-cent yield, are holding their own at around $20 (Canadian).

Liquor is usually considered the No. 2 sin stock, but remains a very profitable place to invest. The companies with the best array of top brands, which can command prices above those for common or generic products, tend to be the most profitable. Indeed, the most expensive products, which some people buy for prestige as much as consumption, are often sought out because of their prices.

Diageo PLC (DEO-NYSE), based in Britain and traded in New York as American depositary receipts, has seen its share price rise from $50 (U.S.) in mid-2004 to $75 in early March. The company controls Smirnoff vodka, Johnnie Walker scotch, Tanqueray gin, Guinness stout and Bailey's Irish cream. It yields 3 per cent and is an industry favourite. An aggressive marketer of its upscale brands, Diageo is able to maintain hefty margins on products that are bought precisely because they are expensive.

Constellation Brands Inc. (STZ-NYSE) markets Corona beer, Black Velvet whisky, and Australian wines. It is the largest wine maker in the world and recently acquired Vincor Canada.

Sales have grown at an average annual compound rate of 19 per cent a year for the three years ended Feb. 28, 2006.

Corby Distilleries Ltd. (CDL.A -TSX) makes whisky and other spirits and liqueurs, and imports wines. Earnings per share more than doubled for the 12 months ended Sept. 30, 2006.

Brown-Forman Inc. (BF.A-NYSE) makes Jack Daniel's sour mash whisky, Southern Comfort and Canadian Mist liqueurs, and also markets fine china and luggage. Those non-beverage products dilute returns from the booze part of the business. Over all, sales have been stagnant for the three years ended April 30, 2006, but the company has increased its annual dividend by 50 per cent to $1.20 in the last three years.

© 2007 The Globe and Mail. All rights reserved.

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