Socially responsible investing, or investing that takes on certain "moral" characteristics, has become the hot trend in recent years. Pax World Investments created the first socially responsible fund back in 1971 and plans to issue new social ETFs based on its funds. iShares' recently launched both the KLD 400 Social Index (NYSE:DSI) and the KLD Select Social Index (NYSE:KLD) to track the largest two social investment indexes.

However, investors wanting to make the world a better place may be selling themselves short in the process. Responsible investing mandates the elimination of alcohol, tobacco, gambling and defense companies from their portfolios and indexes. In the world of profit-driven investing, choosing a stock for what it doesn't do may not be the best strategy for a winning portfolio. In fact, sin stocks seem to have an edge. According to a recent study published in the Journal of Financial Economics, companies related to alcohol, tobacco and gambling have produced yearly returns 3.5% higher than other stocks. (For a quick refresher, check out A Prelude To Sinful Investing.)
Cashing in on Corruption
Investing in vice industries comes with other benefits aside from the higher average returns. Alcohol and tobacco tend to sell well even in economic downturns. Consumers may trade down to less expensive brands, but they still smoke and they still drink. Institutional managers also own, on average, only 23% of the outstanding shares of a sin company versus 28% for an ordinary firm. This could be the reason that sin stocks tend to have a 15-20% discount on valuation metrics, allowing many of them to offer outstanding dividends. In addition, many of these companies, with the exception of casinos, have very conservative balance sheets. After all, if your product is at risk of being regulated, it pays to not overspend. (For more, see Survival Tips For A Stormy Market.)

Cigarettes, Booze and Gambling
This is one area of the market in which individual companies shine over a broad sector approach. There is an active mutual fund in the space, USA Mutual's Vice Fund (VICEX), but individual investors may have better results picking quality companies on their own. (For related reading, see Socially (Ir)responsible Mutual Funds.)

When Altria (NYSE:MO) spun off its international division in order to free itself from an increasingly unfavorable U.S. regulatory market, Philip Morris International (NYSE:PM) became the dominant player in the tobacco world market, selling approximately 870 billion cigarettes in 2008. The company's products are sold in more than 160 different countries, including the ever-coveted BRIC nations. The stock makes a perfect addition to play the consumers in those nations. The company trades at a price to earnings ratio of 15, and yields a market-beating 4.7%.

The percentage of U.S. adults who consume alcohol is holding steady at 64%. However, what they are drinking is changing. Whiskey is making a huge comeback, with 1.3% in total worldwide volume growth. This bodes well for London spirits maker Diageo (NYSE:DEO), which receives a huge portion of its revenue from whiskey. The company owns such brands as Captain Morgan, Johnnie Walker, Tanqueray and the world's top selling spirit, Smirnoff Vodka. Shares of Diageo yield an impressive 4.6%.

In gambling, "the house" always wins, and this is true for the suppliers to the casinos as well. International Game Technology (NYSE:IGT) produces slot machines and other gaming products, including movie-based slots, and Wheel of Fortune branded games. Gambling has become a favorite pastime in China as well, and new casinos are being built in Macau. International Game Technology is seeing increasing revenues from these projects. Shares of IGT yield 1.30%.

Bottom Line
While socially responsible investing has its merits, investors adopting a pure moral portfolio maybe missing out some nice gains. This sector of the market has traditionally produced solid returns, despite the economy. The preceding three companies make wonderful additions to any portfolio. (For related reading, check out The Evolution Of Sinful Investing.)

Related Articles
  1. Economics

    India: Why it Might Pay to Be Bullish Right Now

    Many investors are bullish on India for all the right reasons. Does it present an investing opportunity?
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  4. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  5. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  6. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  7. Investing

    3 Things About International Investing and Currency

    As world monetary policy continues to diverge rocking bottom on interest rates while the Fed raises them, expect currencies to continue their bumpy ride.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
Trading Center