Sin stocks are publicly-traded companies that produce or generate a product or activity that may be considered immoral or unethical by some people's standards. This can include alcohol and beverage companies, and cigarette and tobacco companies. But the term sin stock doesn't just pertain to liquor and cigarettes. It also includes gambling companies, war and weapons companies, and those involved in sex-related industries.

One of the most popular segments that makes up this sector is the liquor industry. While there are many companies to choose from, two key names that come to mind are liquor producer Diageo (DEO) Constellation Brands (STZ) which makes beer, wine, and spirits.  This article looks at what it means to invest in sin stocks, the market for liquor companies, as well as some of the key financial ratios for each company.

Key Takeaways

  • Alcohol is one of the most popular segments in the sin stock industry.
  • There is a common misconception that investing in alcoholic beverage companies will always be profitable because of high demand for liquor.
  • Companies like Diageo and Constellation performed poorly during the economic crisis. 
  • Americans are continuing to drink less alcohol because of a drive for more healthy lifestyles.

Profitable Sin Stocks: A Fallacy?

There is a common theory that investing in sin stocks will always be profitable. That's because there's a belief that the market for certain products like cigarettes and alcohol never dies down. The idea is bolstered even further by the notion that people tend to drink and smoke excessively when the stock market tanks—likely out of frustration—further boosting sales of sin stocks. There is some truth to this.  These goods are considered consumer staples—products people may continue to buy even when the economy is weak. Demand for consumer staples tend to be noncyclical, meaning consumer demand is consistent all year long. But, there's always an exception to every rule, and this theory has many cracks.

Alcohol may also considered by some to be a luxury good, and therefore, part of consumers' discretionary spending. Depending on someone's personal circumstances, they may decide to stop buying their weekly bottles of wine or beer, or stop going to the local bar if they can't afford it. That's probably why the stocks of both Diageo and Constellation Brands performed relatively poorly during the 2008 financial crisis. After all, in down economies, investors seldom rush to buy alcohol stocks. 

Investors seldom rush to buy alcohol stocks when the economy weakens.

Even in healthier economic climates, sin stocks are never a sure thing, and different companies can behave differently, under similar circumstances. Case in point: In 2015, Diageo depreciated 11.63%, while Constellation appreciated 54.93%. This difference may be explained by the fact that Constellation is a smaller company.  Companies that are more nimble tend to outperform in bull markets.

The Liquor Market Overall

As consumers look to more healthy lifestyles, demand for alcohol has been waning, according to IWSR, which provides market analysis about the alcoholic beverages industry. In 2018, the group reported a decline in alcoholic beverage consumption among Americans for the third year in a row.

Demand for beer dropped from 78.9% to 78.3% between 2017 and 2018. IWSR reported that while beer volumes dropped, consumers are still interested in craft beer. But that isn't the case for hard liquor, which still remains popular among consumers. Sales in spirits rose in 2018 to represent 37.3% of the U.S. liquor market. Premium liquor was the highest part of this segment, followed by value, high-end, and super premium spirits.

Diageo vs. Constellation

Diageo

Diageo was founded in 1997 after Guinness and Grand Metropolitan merged and is based in London, U.K.  The company has a presence in many different parts of the world. But if you don't recognize the Diageo name, you may know some of its key brands. The company is the maker of Smirnoff vodka, Johnnie Walker, Bailey's, and Guinness. Diageo also has a stake in a number of high-end brands including Veuve Clicquot and Moët Hennessy. 

As of June 5, 2020, Diageo's market cap was $85.67 billion, and its share price closed at $163.52. The company offers a 1.87% dividend yield. Its return on equity was reported as being 32.86%. As of December 2019, Diageo's debt-to-equity ratio (D/E) was 1.14. The company's operation cash flow generation as of 2019 was reported to be $3.25 billion.

Constellation

Formed in 1945, Constellation Brands is based in Victor, New York. The company has more than 100 different brands under its umbrella including Corona, Modelo Negra, High West Whisky, and Svedka Vodka.  Constellation has been expanding primarily through acquisitions. Some of its notable purchases include wine brand Robert Mondavi in 2004 as well as the American arm of Grupo Modelo's beer business from Anheuser-Busch in 2013. 

Constellation's stock closed the trading day on June 5, 2020 at $181.42, with a market cap of $34.9 billion. The company's dividend yield was 1.71%. Its D/E ratio was 0.9, while its return on equity (ROE) was reported at -0.1%.  The company's operation cash flow as of 2019 was $2.2 billion.

The Bottom Line

This is simply a matter of your investment philosophy. If you’re looking for stock appreciation and you're willing to accept the potential for increased downside risk, then you might want to consider Constellation Brands. If you’re more risk-averse and would like to collect dividends, then you might want to consider Diageo. Just keep in mind that neither stock is likely to be exceptionally resilient if the broader market falters. That said, this should just be a temporary hit in both cases.

Dan Moskowitz does not have any positions in DEO or STZ.