This article first appeared in Wealth, The Edge Malaysia Weekly on October 28, 2024 - November 3, 2024

Sin stocks are frowned upon by some investors these days as the sustainability investing trend takes the world by storm. Others who are more contrarian continue to favour selected counters with improving fundamentals and decent dividend yields. Should one avoid sin stocks at all costs or keep a close watch over this space for bargain hunting?

Investors who are looking for steady and decent dividends could be better off looking at non-sin stock counters, such as banking and insurance. But that doesn’t deny the fact that selected sin stock counters continue to pay out decent dividends while increasing their profit and revenue, such as Heineken Malaysia Bhd (KL:HEIM), which has a dividend yield trailing 12 months of 5.5%. Sceptics of the sustainability trend could see these companies as undervalued, given the prices they are currently being traded at.

In an interview with Wealth, AHAM Capital equity analyst Darren Tan says sin stocks are now being traded quite cheaply as compared to their historical valuations. For instance, tobacco stocks used to trade at a price-to-earnings (PE) ratio of 20 times a decade ago. It is now closer to 10 times. The same is seen with breweries, with PE ratios dropping from 25 times to below 20.

Such a view resonates with Peter Lim Tze Cheng, founder and chief research officer at Trident Analytics Sdn Bhd. British American Tobacco (M) Bhd (KL:BAT) is another example. The counter was traded at a rather high PE multiple in the past, but the ratio has fallen on the back of a rerating due to a change in its business model, industry dynamics and shifts in consumer preferences.

Ho Kok Mun, who shares his personal investment journey through his book, How to Make Money From Your Stock Investment Even in a Falling Market, used to favour sin stocks due to their stable demand and attractive dividends. His personal views on these counters, however, have shifted rather drastically in recent years.

Sharing his personal experience, Ho says sin stocks have not been performing well over the past decade. Their share prices and yields have both declined over the long term.

“Most sin stocks are priced fairly nowadays considering their uncertain future and dividend yields [which range from 4% to 7%]. I don’t recall any that has more than 10% dividend yield nowadays,” he says.

Some of the largest publicly traded Malaysian companies considered as sin stocks, in terms of market capitalisation, show dividend yields that range from 3.73% to 7.54%, based on the closing share price on Oct 16, 2024. These companies are Genting Bhd (KL:GENTING), Genting Malaysia (KL:GENM), Heineken Malaysia, Carlsberg Brewery Malaysia (KL:CARLSBG) and BAT.

Nowadays, Ho prefers to diversify his portfolios to include stocks that are less exposed to regulatory and ethical concerns. Selected banking, insurance, consumer or government-linked companies are his favourites when steady dividend yields are key.

Meanwhile, Lim says investors seeking dividend-paying stocks can consider real estate investment trusts (REITs) as an alternative to sin stocks. Sectors such as construction and property may provide better growth prospects and less ethical baggage compared to sin stocks.

“For those who have invested [in sin stocks] in the earlier stages, your holding cost may be very low with all the dividends that you have received. If you want to go into [sin stocks] now, you’re entering at a stage where the prospect of growth is pretty limited,” says Lim.

Yet it could be a case of the glass being half-full or half-empty. Some investors who aren’t that bothered by the sustainability trend could see these stocks as undervalued, says FA Advisory Sdn Bhd CEO Bryan Zeng.

Investors who are willing to overlook ethical concerns and focus on financial metrics may find opportunities in sin stocks that the broader market has shunned, he adds.

“Historical data suggest that sin stocks can outperform the broader market, particularly when their underlying business fundamentals remain strong despite negative sentiment,” he says.

Investors shouldn’t shun sin stocks completely. Rather, they can consider making a decision based on several key factors, including a company’s dividend payout ratio and cash flow. The former indicates the proportion of earnings distributed as dividends to investors, says Alvin Vong, principal CEO of Equities Trackers Holdings Bhd.

Equities Trackers is a LEAP Market-listed firm that provides users with data and analytics on public listed companies.

A high dividend payout ratio signals a commitment to returning value to shareholders, says Vong. “Some [sin] stocks stay stagnant for a long time. The fundamental numbers get better yet the prices don’t reflect that,” he notes.

Some companies in this sector have demonstrated consistent revenue and net profit growth, which indicate their resilience, adds Vong. However, market perception on sin stocks can be influenced by short-term sentiment that leads to fluctuations in prices.

For example, Carlsberg saw its net profit increase by 54.97% to RM327 million in 2023 from RM211 million in 2014. Meanwhile, Heineken saw its net profit increase by 94.94% to RM386 million in 2023 from RM198 million nine years earlier.

The share prices of Carlsberg and Heineken have also increased, with the former traded at RM23.22 in end-2023 from RM7.93 in end-2014. Heineken’s share price increased to RM18.56 from RM7.60 during the corresponding period.

“I think the market will always behave rationally in the long term, but in the short term it is very sentiment-driven,” he says.

Many investors tend to avoid companies involved in industries that are considered harmful to society such as tobacco, alcohol and gaming, due to the growing trend of sustainability and ethical investing. Additionally, the growing demand for shariah-compliant investment products, which by default excludes sin stocks due to their non-alignment with Islamic principles, has an impact on the attractiveness of sin stocks.

Could this trend further place the future of sin stocks in doubt? This is in view of concerns about some fund houses and research firms reducing or ceasing coverage of these companies, leading to price pressure and lower valuations.

“The key reason for us to cease coverage on sin stocks is purely demand-supply and commercial. As more asset management companies [which are our clients] embrace responsible investing, they are no longer investing in socially undesirable businesses including breweries, tobacco product makers, number forecast operators and casino operators.

“So, it makes sense for us to channel our research resources towards the coverage of investable businesses by our clients,” says a sell-side research house when approached by Wealth for an interview.

However, not all asset management firms and their clients shun stocks outright based on sector classification. Rather, they assess the ESG risk of these companies, how they manage the risks and if they have a transition plan to make their businesses more sustainable.

David Loh, deputy head of equity at AHAM Capital, says the firm integrates ESG into its investment decision-making process. This means AHAM evaluates a company’s ability to manage its ESG risk and considers the implications that it may have on a company’s financial performance.

“We do not exclude a company purely on its sector classification. Our ESG research draws from various data sources, including reports from independent research providers, global norms and negative screening, company public disclosures and our internal scorecard,” says Loh.

Trident’s Lim observes that ESG is not a primary concern for conventional funds. And retail investors are not as sensitive to these issues as compared to institutional investors, as their primary concern is generating returns.

Vong of Equities Trackers Holdings agrees.

“For fund houses, at the end of the day, it’s about the fundamentals. It’s about growth. If you go back 20 to 30 years, these companies were seen as growth [stocks]. They were seen as professionally run. These industries have matured a fair bit,” he says.

“Ultimately, whether there is PE compression or not, you’re still driven by the [dividend] yields. If the yields are super high, you are going to get a price discovery,” he adds.

FA Advisory’s Zeng says investors should monitor any ESG initiatives taken by companies offering sin stocks. Sin stocks are under pressure to improve their ESG practices due to their controversial nature. Thus, companies that proactively enhance their ESG performance could improve their public perception, which could then improve stock price and valuation.

Moreover, diversifying investments across different sectors can mitigate risks associated with specific industries.

“Constructing a portfolio with a mix of sin and non-sin stocks can further diversify risk. There is no fixed or recommended allocation. It depends on the investor’s preference,” notes Zeng.

One should also be aware of value traps, where investors perceive a company as undervalued as it falls out of favour with the market, and that its share price could rebound. But that might not happen, says Lim.

“It all boils down to how you define inefficiency. Some may argue that traditionally, sin stocks [such as] alcohol companies were trading at 25 times PE [but are] now trading at 16 times PE. They will deem there is an inefficiency in the valuation. 

“But what if that is not a temporary inefficiency? What if there is a new valuation due to fewer people being interested in sin stocks?” Lim wonders.

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