If You Find Tobacco Stocks Unethical, You Should Buy Tobacco Stocks | The Conservative Income Investor

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

August 24, 2013 by Uncategorized 25 Comments

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.