If You Find Tobacco Stocks Unethical, You Should Buy Tobacco Stocks

Something worth thinking about is the nature of second and third order effects and how the consequences of certain actions can be much different than what we actually intend.

Take something like tobacco investing. If you read any well-circulated article that discusses Altria, Philip Morris International, Reynolds American, or Lorillard as a potential investment, the comment stream generally veers away from the economics of tobacco investing towards the morality of tobacco investing.

You don’t have to go too far to find someone saying: “I don’t invest in tobacco stocks for moral reasons”, and the statement is usually wrapped up in a tone of smugness and moral superiority.

Most likely, that person is not having the detrimental effect on tobacco companies that they anticipate, for two reasons:

1. When you buy shares of Philip Morris International on the open market, you are buying an existing share (as opposed to a secondary offering when a new ownership unit is actually created). If Philip Morris International were issuing 10,000,000 new shares to raise capital to grow in China, then it would be logical to avoid those shares on the grounds that you don’t want to give Philip Morris International the money to grow its operations. But if you place an order at Schwab to buy 100 shares at $85.00 each, you are buying an ownership unit that already exists. You have no effect on the tobacco company in that case, because you are just a placeholder. If not you, that $3.40 annual dividend check would go to Joe next door. Once a share exists and has a shareholder, you can’t make that share disappear by not purchasing it. Stock ownership is like attending a sporting event where every seat in the bleachers must be filled at all times. Refusing to attend the game won’t create an empty bleacher seat.

2. Most tobacco companies are currently engaging in stock buybacks, in particular Lorillard and Philip Morris International. By refusing to buy a tobacco stock, you are theoretically lowering the price of the stock by decreasing the demand. If millions of Americans share your attitude, you can lower the price of the stock because there is a smaller investing pool of people that could buy the shares (of course, this only affects valuation, but business performance. The management teams at the tobacco companies can still make you rich through the back door by giving you raising the dividends). Think about what happens when the price of a stock is lowered while a company is conducting buybacks. Each buyback dollar will have a stronger effect at increasing the earnings that each share represents, and this makes it easier for tobacco stocks to have an even higher dividend growth rate because the company doesn’t have to pay dividends to the shareholders that got bought out at a discount. In essence, the refusal to buy tobacco stocks could, in aggregate, lower the price of the stock (and thus make the buyback more effective) so that tobacco investors actually get richer due to your non-participation. Talk about an unintended consequence.

I mention all of this for one reason—to point out how the effects of an action aren’t always what you expect once you take into account the other variables in the equation. If you’re concerned about doing the right thing, the best thing to do is buy those 10,000 shares of Reynolds American and use the $25,200 in dividend checks to donate to a good cause of your choice, perhaps even tobacco prevention and anti-smoking initiatives. The hard part is figuring out what will happen to your capital (e.g. the 10,000 shares of Reynolds, Altria, Lorillard, or what have you) if you happen to succeed in your quest to eliminate tobacco usage.

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25 thoughts on “If You Find Tobacco Stocks Unethical, You Should Buy Tobacco Stocks

  1. Valuefan says:

    Excellent points. In addition, PM and other tobacco companies actually have a "partner" who goals are to to disrupt its business. What i mean by that is the excise taxes that tobacco companies collect and are then sent over to the government for smoking cessation programs are funded by a robust business in selling cigarettes. So if you desire to have more programs in smoking cessation you should invest in the companies that have, and will continue to, fund them: PM.MO and the rest of the tobacco companies. I feel that these stocks offer extra protection in that the governemnt wants them to survive and prosper so they can continue to fund their health programs.

  2. Edward says:

    Pretty good rationalizations. Where do you draw the line? Is there any line? Invest in Porn, Defense, Alcohol, etc.? I suppose if it's legal in USA then its fine.

    I know a guy at the gym who will not buy MCD, says they sell garbage that make people sick. Can't argue but I'm lovin' Its 5.5% div on cost and I don't eat there:)

    But I don't/can't buy tobacco stocks for the best reason, my wife doesn't want me to! Happy wife is worth much more than PM profits:)

  3. charles says:

    The problem is the tobacco companies' actions, while profitable, are abhorrent.

    They could sell tobacco, and make money… but they have to… they just have to amplify the addictiveness 5,000%, they have to make people physically dependent, to the point they need terrible operations… that completely ruin their lives and their family's lives, for a few years before they (tobacco company's customers) finally die.

    The companies have put more Americans into the ground than, not just every War America has fought; but every War that has ever been fought in history. It's just 'legal genocide.' Furthermore the liability to the companies has legal precedent to be crippling — the companies won't settle for a few tens of thousands of dollars, go to court and lose tens of millions of dollars.

    1. Dave says:

      Would you say that the products produced by Lockheed Martin and Raytheon are abhorrent, because "they kill people?" What about Norfolk Southern and CSX corporation? They haul dirty coal and oil shale that pollute our environment. Coca-Cola? They poison people with their sugar drinks. Nestle? Sugar products. McDonalds? Obesity. Abbott Labs and the other drug companies? A culture of drug abuse and addiction. Disney? Pure fantasy that deludes people from the realities of life.

      Maybe we should invest our money in mason jars that we bury in the back yard? Your "protest" and your abhorrence of tobacco stocks is very humorous and misguided. I wonder how you feel about the other companies? Will you rationalize your opinions of those companies and why they are good and tobacco is bad?

      No one ever forced me to put a cigarette into my mouth. I chose it on my own. If we hold every company and the product they sell for our lack of self control and discipline, we might very well find ourselves living in caves, very much like our ancestors did thousands of years ago.

      Ignorance seems to be bliss in this country these days.

  4. ZaVodou says:

    I have decided to buy tobacco stocks when I had to inhale unwillingly the smoking of tobacco smokers again.

    That was four years ago. I think it was a good decision and is a good compansation in future when I have to inhale unwillingly again.

    Regards

    ZaVodou

  5. Armchair Economist says:

    Tim,

    There are some "ethical investors" in my family and I sometimes try to explain to them that what they are doing will not have the desired effect, but it never works. So I enjoyed seeing a post I agree with. It is a tough position to explain without being accused of "rationalization" as someone did above. Here's some more rationalization: any company that is really successful probably got where they are and stays there in part by cheating, bribing, stealing, and bullying.

    It is probably almost impossible to find an investment that is ethical and profitable. Running down your master list of stocks, all I see is producers of dirty fossil fuels, unhealthy addictive substances from tobacco to liquor to sugary soda and snacks, fatty french fries, crippling consumer debt, military pork, and of course drugs with dubious side effects that are constantly pushed to all consumers on TV.

    To decline to profit from any of this is to reject capitalism.

    Still, we can explain it all we want, but ethical investors do have a point. As a shareholder you are profiting from the enterprise you own stake in. Selling or refusing to buy a company's stock may help them in some ways as you said, but there are also ways it hurts them that we can't ignore. Company management normally owns stock in the company. They want the price to go up. They may also have a lot of employees to whom they have granted options as compensation that are only worth anything if the stock goes up. Plus, for better or worse, management is judged by share performance as much as by business performance. And lastly, if the company did want to raise capital by issuing additional shares, the share price informs the effectiveness of this.

    Ethical investing makes more sense though if you do it in the bond market instead of the stock market. By declining to buy a company's bonds, you can have an incremental effect on the price of their debt and hurt them directly. Still, by doing that you just help unethical bond investors make a little more money and the company probably won't notice.

  6. "All wars are crimes," said a fictional General in an episode of "The West Wing" years ago. I think one might argue similar about investing: It's all unethical. The analysis of how non-black-and-white both are can now begin.

    Some of my liberal acquaintances would blanch if they knew I own shares in defense companies LMT, UTX, NOC and RTN and tobacco maker RAI. I blanch knowing the real estate agent among them pushed housing on folks who would not qualify twenty years ago for a mortgage. One specialized therapist takes state and federal funds in payment for her work but can present no convincing proof of a positive outcome for the money she is paid. The 'financial planner' works for a company that requires her to sell only loaded mutual funds with an expense ratio over 1%. Many drive gas guzzling SUVs, increasing U.S. dependence on foreign oil and so war in the Middle East. One acquaintance goes nuts when I (a registered Democrat and moderate liberal) argue that the military is a way out of poverty and into a good education for many young people. One should try for ethical conduct. When it comes to stock investing, I think 'judge not lest one be judged' is good counsel.

    I appreciate McAleenan's high quality of writing here and how he weaves his reflections from reading the classics into his thoughts. Wondering what makes a young financial writer of this caliber (not perfect yet still superior in thought to some 90% of others in my never humble opinion), I noticed recently on the net from where he graduated high school. As they might say in the better funded suburban public schools, what a lucky songun. Go sister schools Villa and Cor Jesu. Setting aside the religious commentary and a carefully muted politically conservative leaning, I am glad McAleenan broke away from Seeking Alpha. They do not deserve him.

  7. James Hoopes says:

    Tim,

    I greatly enjoy your blog, but you're missing some important facts here.

    It is true that lower demand for tobacco company stock will lower its price and make buybacks more profitable.

    But it is also true that those lower stock prices make for lower capital appreciation for investors in tobacco company stocks. So ethical investors do have some negative impact on tobacco industry profit.

    Also, you focus on only one of the three ethical issues involved in any moral decision.

    The only ethical issue your post recognizes is utilitarianism or consequences. Even here your argument is limited because you focus on financial consequences but not health consequences. You also ignore the effect of reputational consequences for investors in putatively unethical business, the kind of reputational consequences, for example, that led corporations to leave South Africa until apartheid ended. It is far too early to assume that similar reputational consequences will not eventually affect the behavior of people (including investors) doing business with big tobacco.

    Just as importantly, you ignore the ethical issue of virtue. What kind of character do I want to develop in myself? Do I want to get into the habit of profiting from preying on addicts?

    You also ignore the ethical issue of deontology or duty. Do I have an obligation to my fellow human beings not to sell them products that will kill a fair number of them?

    You're right to assert that tobacco raises complex issues. But you leave out some of the complex issues.

  8. K. Hug says:

    Well, I never buy shares of a company that knowingly puts the lives of countless people at risk. The whole idea of a tobacco company is making money by making other people suffer. While it is not a crime, for me, it is highly immoral. Why would I invest in such a miserable company? It doesn't make sense. There are so many fine companies to invest in, why bother with tobacco, alcohol, weapons, porn. These companies make no one happy, and happiness is even more important than making money. I can as easily invest in KO, PG, JNJ, WFM and collect my dividends.

    1. stephen J Melnykevic says:

      K. Hug

      Ko causes obesity which leads to a large number of health issues that arguably kill more people than smoking.

      PG makes cosmetic products which may cause eating disorders in younger females with self esteem issues.

      JNJ has put products on their shelves that are defective and have caused deaths in the past.

      WFM has questionable labor practices.

      Will I not invest in any of those products because of those concerns? The answer is no, I plan to continue to buy those stocks in addition to my large tobacco and oil holdings for exactly the reasons pointed out by Tim.

  9. Tim, I enjoy your well written articles – but must make issue with this one.

    First, let me say I own PM – so I'm not going to pass judgement on someone for investing in Tobacco Stocks.

    However, I think the decision whether or not to do should have nothing to do with whether you think your investment has a detrimental or positive effect on the tobacco company. When you purchase shares of a company, your are purchasing a portion of a business.

    The moral question a tobacco investor needs to answer is are they comfortable with owning a (portion of ) a business that makes money doing what Tobacco firms do.

    While we have the comfort of 'distance' (both physical distance, and the corporate shield) from their operations, in effect we as investors are not much different than a neighborhood drug dealer working to gain kids as new customers.

    I think a lot of Tobacco Investors (including myself) use the shield of indirect involvement to justify actions we would never take directly ourselves.

    Hmm..if your article was intended to make us think, it definitely succeeded here:)

  10. says:

    I'm less interested in whether owning these companies is ethical than whether or not they will continue to be as profitable in 20-30 years. Smoking is losing it's allure for many young people, not to mention the increasing smoking bans are just making smoking an inconvenient habit to pick up. You would think that these tobacco companies would try to keep their existing customers alive and smoking longer with some sort innovation—something similarly addictive and less poisonous. I haven't invested in tobacco simply because I don't see a shining future for it.

  11. says:

    To further the argument about the morality of the Big Tobacco, a few of the Big Tobacco companies are actually investing heavily into electronic cigarettes, which do not have the known cancer-causing agents. There are plenty of companies out there do operate on ethical fine line, but there are not as obvious as the Big Tobacco. I am a shareholder of Boeing – they may make fancy 777 and 787, but there also make rockets and bombers. My take is the world is not fully black-and-white. I do not see there is much ethical concern in investing in the Big Tobacco.

    If there is two thing I do worry about investing in Big Tobacco is:

    1) Their attempt to manipulate the political environment – this means a sudden change of political environment poses a risk to the business. Given the traditional negative image of Big Tobacco (but some of the negativity is not fully justified), they are more subject to sudden regulatory changes.

    2) Another problem is demographical: the number of smokers is generally on decline for the last 10-20 years. That is reflected in the P/Es of the major tobacco companies – a low P/E / high dividend can mean the stock is undervalued, but it also means the investors are expecting negative trends in the company's earnings. If I am after high dividend, why wouldn't I to invest in utilities (Southern, Duke, etc…)?

  12. martino gustaver says:

    What I do not like in Tobacco companies is the advertising they do in some countries and this is sickening. other than that, ethical investing is never ethical.

    For example: Many countries organise tobacco production and sale, therefore benefits from it, paying your taxes is accepting the tobacco business. The state organises wars and bomb attacks also. Not voting against wars and not protesting makes you an accomplice.

    Also, the Tobacco company makes profit, pays workers. Workers and shareholders spend that tobacco money in grocery shopping or get a credit card or mortgage. Is the retail company or bank an ethical investment? They profit from tobacco.Your bank probably owns tobacco stocks in its funds anyway.

    Invest in a car company. Car kills people and destroy the envirronment.

    Lets say we all take the tobacco companies down. We have two options: Make the companies state owned and the profit from tobacco is just here to ofset its society costs. Its kinda whats already happening with taxes on tobacco anyway. Another option: Outlaw tobacco. The corporate profits and wages paid will now go to south american cartels and european mafias. Thats a much worse outlook.

    As long as customers want tobacco, the best solution is to legalise its profits. That's also my position for other drugs. Why do we allow mafias and crime cartels to thrive is uncomprehensible to me, see prohibition.

  13. I don't invest in cigarette companies. I know that my avoidance is not changing the world I just don't want my dividends coming from that source. Its a personal choice as I have seen the damage up close and in person.

    However I have no qualms or disrespect to those that do as its an emotional choice not a fundamental profit choice.

    It would be very hard to have a cruelty/suffering/addictive free portfolio.

    Big oil does terrible damage to the environment (Nigeria in particular).

    Defense contractors make products specifically to kill.

    Coke and McDonald's have specific formulas to make their products addictive. Less so then cigarettes but still intended to get people to keep buying.

    Walmart in how they treat their employees.

    You can find an ethical problem with just about any company.

  14. Now with that said…. One argument for the owning of big tobacco….

    In the U.S. we will be forced to pay health insurance.

    If we are all sharing the cost of health care among us yet the smokers are the ones who will be needing far more health care needs then non smokers, the non smokers will be paying more for receiving less…

    Tobacco dividends are a way the smokers can pay back us non smokers for having to help pay their medical bills.

  15. Al says:

    your 1st point makes no sense, buying stocks from the secondary market still gives money to the company and allows them to use that money to invest in new projects, such as China. The stock price will go up and the company will have more money

  16. Jay Tank says:

    Tobacco companies are not going anywhere but up in the forseeable future. With the growing acceptance of vapor cigarettes in the workplace and social environments, along with the eventual legalization of marijuana throughout the US, there will be plenty of room to grow for the domestic companies like MO, RAI, VGR and LO. And the foreign stalwarts like BTI and PM will continue on their merry way towards conquering the emering markets as planned. The return on investment in companies like these is ridiculous and the amount of cash they accumulate is mindboggling. Hence, their dividends tend to hover around 5% or so.

    I personally have half of my equity position of my portfolio in big tobacco and big oil, and they have done nothing but churn out more and more cash every year, and I only expect this to grow in the future.

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