For investors, the world of "sin" stocks has long been a place to find stable returns. Product categories like alcohol, tobacco and gambling have a recession-proof nature that often makes them portfolio staples. Most investors are OK with holding positions in these vices despite their "sin" connotations. The fourth category of sin stocks - weapons manufacturers - is a different matter.
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With issues such as gun control, budget battles and military conflict filling the headlines, many investors simply don't feel comfortable owning the various defense contractors and weapons producers. In fact, two of the nation's largest pension funds - California's CalPERs and CalSTRs funds - are planning to review any investments in firearm manufacturers in light of December's Newton, Connecticut tragedy.
Given the defense firms' long-term outperformance, however, one has to wonder if these investors are cheating themselves out of potential returns. Looking past the potential moral implications, the sector does offer plenty of value for long-term investors.
So the question remains: Should you invest in weapons stocks? We'll take a look at the answer.
For investors willing to look past the potential moral hazards of owning defense and weapons stocks, the long-term gains are there. Since its inception in 1991, the Dow Jones Aerospace & Defense index - which tracks companies such as Lockheed Martin (NYSE:LMT) and General Dynamics (NYSE:GD) - has produced a 12.71% annual return. At the same time, the long-term prognosis for the defense and weapons firms remains pretty good. While the recent budget battles could mean a Department of Defense that is 5 to 10% smaller than current levels, many analysts expect sales of military hardware to be robust as the U.S. begins to look toward Asian countries as buyers.
Many defense firms are also branching out and gaining international contracts. Those contracts are one reason the Aerospace Industries Association projects that U.S. aerospace sales will increase 2.8% in 2013 to reach $226 billion in revenue. Threats such as Iran, as well as China's growing military presence, are leading to spending by smaller nations as they look to beef up their own weapons systems.
Looking out even longer term, concepts such as cyber security and unmanned drones are the future and will drive revenues for weapons producers such as AeroVironment (Nasdaq:AVAV).
So, as a portfolio component, the defense contractors and weapons producers certainly make sense to own.
Potential Internal Conflicts
The obvious conflict investors face in deciding whether to add weapons firms to a portfolio comes down to a simple question: Are you comfortable owning a company that makes a product designed to take someone's life?
For some investors, that's not an easy decision to make.
The recent school shooting in Newton, Connecticut has opened up a new dialogue on gun control and violence. Some investors' morals may conflict with profit motives. This makes owning weapons producers pretty prohibitive, and recent moves by some big pension funds are showing that social commentary outweighs those profits.
That shift in thinking by some of the world's largest investors may begin to shift public perceptions as well. Banning assault rifles or other automatic weapons could hinder stocks such as Smith & Wesson (Nasdaq:SWHC).
Overall, individuals need to think hard about their own portfolios and motives before adding this sin stock sector.
The Bottom Line
While most investors are OK with adding booze, gambling and tobacco to their portfolios, defense and weapons producers are another matter. Social and moral obligations need to be weighed before jumping in. For those that do buy the group, there's plenty of upside ahead, in both individual stocks and in mutual funds - even with the recent budget issues facing the U.S.
At the time of writing, Aaron Levitt did not own shares in any company mentioned in this article.