As Japan mulls legalized gambling as a means of closing its budget gap, Charles Sizemore of Sizemore Investing selects four stocks likely to benefit, but tells why this sector is no sure bet.

All around the world, same song. And by “song,” I of course mean “economic motivators.” It seems that every country in the world faces the same problems (yawning budget deficits) and is looking to the same solutions (raising revenues through unconventional means).

As a case in point, consider this recent headline from the Wall Street Journal: Japan Is Pressured to Legalize Gambling

Tired of seeing their citizens leave their yen on the gaming tables of foreign casinos, the Japanese government is strongly considering making a bet of its own by legalizing gambling.

Any moral qualms aside, it makes sense. Japan is the most highly-indebted developed country in the world, and its budget deficits routinely top 8% of GDP. Closing the gap through tax hikes or spending cuts risks weakening an economy that is perpetually on the cusp of recession; better to raise revenues by less-conventional means.

It’s not uncommon for countries to legalize certain vices during hard economic times. America’s prohibition of alcohol lasted throughout the roaring 20s, but it barely survived three years into the Great Depression.

With the US government running budget deficits among the highest in the world, and with anti-government sentiment bubbling over from both the left and right, it’s fair to wonder whether legalization of “soft” drugs like marijuana may be in the cards before we finally pull out of the current Great Recession.

The economics are straightforward enough; prohibition and enforcement of vice laws are a governmental expense, whereas legalization and taxation of vices are a source of revenue. (For the history buffs out there, it is no coincidence that the Progressive movement favored both the Federal income tax and the prohibition of alcohol; the income tax was a necessary evil to plug the holes left from vice taxes that would never be collected again. Once the income tax was in place, booze taxes became expendable.)

Japan’s change of heart regarding gambling is little different from those of many American states, particularly in the South. Watching the gambling and tourism windfalls going to Las Vegas and Atlantic City, riverboat and offshore casinos became a way to keep some of those touristic dollars from leaving the state. Likewise, Japan has seen its citizens fly to Las Vegas for decades, and to Singapore and Macau in more recent years.

Let’s take a look at some of the companies likely to benefit from the legalization of gambling in Japan.

The Wall Street Journal mentions Las Vegas Sands (LVS) and Wynn Resorts (WYNN), both obvious winners as two of the largest casino operators in the world.

Another route might be to buy what the casinos themselves are buying. Consider International Game Technology (IGT), a major manufacturer of gaming equipment and supplies, or Bally Technologies Inc. (BYI), which designs the equipment and systems needed to properly run a casino. A surge in casino building in Japan should be quite good for business.

Should You Buy Casino Stocks?

A more fundamental question would be “should you consider casino stocks at all.” The Sizemore Investment Letter has been bullish on vice investments for years, but we’ve chosen to focus on tobacco and alcohol stocks; casino stocks have been conspicuously absent.

There is a reason for this: one of the biggest benefits of a good sin stock is the predictability of its revenues. People are not likely to materially cut back their drinking and smoking during a recession. They might, however, decide to cut out that expensive trip to Las Vegas.

The gambling industry, as represented by most casino stocks, is cyclical and at the mercy of tourism and real estate trends. And worse, as gambling establishments proliferate, another one of the casino’s traditional benefits as a vice investment is being watered down: the regulatory restraints that keep competitors at bay. Add to that the propensity of many casino companies to be saddled with high debts and you have a recipe for a volatile, risky investment.

If the global economy continues to recover, gaming stocks will likely have a phenomenal run. But given the risky nature of the sector, more conservative investors might want to find their vices elsewhere.

By Charles Sizemore of Sizemore Investing

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