Sin Stocks: The Natural Choice

By Chris Gallant | April 28, 2010 AAA

Investments in so-called "sin stocks" would sometimes seem to be more accurately labeled investments in "human nature." After all, the average person seems to be consistently willing to bear the costs of serious longer-term consequences in order to fulfill their immediate material desires.


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Be it a nicotine buzz that comes at the cost of consuming deadly carcinogens, or the adrenalin rush of gambling in casino games that result only in the inevitable destruction of the gambler's capital, the pattern of behavior is the same, and has gone on for centuries. It seems to be an innate part of human life, hard-wired into our brains. (For related reading, see The Evolution Of Sinful Investing.)

Smokin' Hot
With that reality in mind, let's look at a particular "human nature" company, Vector Group (NYSE: VGR).

Founded in 1911 and headquartered in Miami, Florida, Vector primarily operates in the cigarette industry. It produces in excess of 150 different types of cigarettes (everyone's human nature is a little bit different, after all), under such brand names as Grand Prix and USA, and is also engaged in the manufacture of private label brands.

Vector's recent trajectory has been positive, its share price currently registering a positive 52-week change of 20%. This share price performance is comparable to competitors such as Altria Group (NYSE: MO) and Lorillard (NYSE: LO), who register in the mid-20% range. Although it does lag behind that of Philip Morris (NYSE: PM), Reynolds American (NYSE: RAI) and British American Tobacco (NYSE: BTI), all of which have seen their shares appreciate by about 40% over the past year.

Sinful Product, Solid Financials
The innate nature of consumers' demand for Vector Group's products has consistently translated into solid financial results for the company. Vector's top-line annual sales have increased from $555 million in 2007 to $801 million for 2009, representing an increase of over 44% in just two years' time.

The stability of its business operations has allowed Vector to grow while continuing to pay out industry-leading dividends. Vector's dividend yield has averaged 9.4% over the past five years - not bad at all for a stock that has seen its split-adjusted share price more than double during that time.

Safety in Numbers
Despite its consistent success, the market is pricing Vector significantly below the valuation assigned to its peers. On a dividend yield basis, Vector's forward annual dividend yield is priced at 9.8%, far surpassing even the next-best forward yield of 6.6% currently offered on Altria shares. (For more, see Dividend Facts You May Not Know.)

Assuming Vector's dividend rate holds up, shares of Vector Group purchased at current prices are poised to produce a solid annual return from this source alone, and any share price appreciation would just be icing on the cake. At the same time, this large dividend yield should prevent significant share price declines, as it is unlikely the market would allow the yield to increase substantially higher from current levels. (For more, see Dividend Yield For The Downturn.)

Natural Conclusion
Despite Vector Group's consistent ability to produce solid financial results, the market has, for whatever reasons, decided to price it at a significant discount to its peers. While few things are certain in the world of finance, it seems unlikely that this discount is fully justified. Human nature being what it is, perhaps the market has been innately driven away from this stock in the short-term, seeking to placate its collective hard-wired drive for bets that give a better gambling buzz. Investors who can ignore such innate stimulus and instead place their bets on Vector shares may find themselves well rewarded for doing so by this time next year. (For more, see Sinful Investing: Is It For You?)

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