The Ethics of Tobacco Investing Revisited

A great question from reader Joe left as a comment on a previous article:

Tim,

This question isn’t directly related to this post but I’d still like to get your thoughts on an investing concern that has been on my mind lately. To what extent do you view your investing life as an extension of your personal life?By that I mean to what extent do the personal morals and ethical values of Tim the man govern the investing decisions of Tim the dividend growth investor?If you ask your typical dividend growth investor if they would be willing to invest in a lucrative but immoral venture, say selling child pornography or crack cocaine, the answer would probably be “absolutely not” regardless of the yield, valuation or growth prospects of the underlying venture.And yet, ask that same investor what their thoughts are about Phillip Morris and they would probably describe what a wonderful investment it is and go on about why you should own it.Do your personal morals ever come into play when buying companies, or do you compartmentalize your conscience, wall it off from the part of your brain that thinks about investments, and make your investing decisions based on the financial prospects of the company?The reason why I’m asking is that I keep identifying stocks of companies that I love from an investing perspective but despise on a human level.I cannot in good conscience own any piece of Phillip Morris knowing the impact that smoking related illness has on the families of smokers.You might say that the smoker made his choice to smoke so you don’t mind taking his money, but his children never made that choice and they are the ones who will suffer when he dies 20 years too soon. I can think of many other examples of lucrative and growing businesses that I cannot and will not own because their primary mission is immoral and destructive.

Joe, great question. My favorite quote that about sums up my thinking on this topic comes from Warren Buffett, who said: “There are 250,000 employees at Berkshire Hathaway. I guarantee you that someone, somewhere is doing something at Berkshire that we do not like.” If you are going to be an enterprise worth billions of dollars, you are going to have business lines and employees that are doing something unethical at any given moment.

Generally, I’m satisfied with the way things are in America because if you want information, you can get it. If someone at a 2 Big Macs, 3 large fries, and several refills of soda every day at McDonalds with no exception, they will trim days off their lives. They will get diabetes. They will get fat. Maybe heart disease. The point is, bad things will happen. Yet, we can look up the calories and health information for every single food product that exists under the McDonalds umbrella.

I just opened up a browser window on my computer, googled the calorie counts for food at McDonalds, and brought this spreadsheet up: www.nutrition.mcdonalds.com/getnutrition/nutritionfacts.pdf

There’s no deceit. There’s no fraud. How can I not respect the right of an adult to act of his own free will to make decisions in life? If you go to McDonalds and get a Coca-Cola for a $1, you can pull out your phone and know right away that the 30 fluid ounce cups contain 280 calories. The knowledge is right there, at my disposal.

In some ways, this is what I love about business: it shows how Americans truly behave, rather than how we want them to behave. When you look at the net profits for Altria (tobacco), Exxon Mobil (oil and gas), McDonalds (fast food), Anheuser-Busch (beer), and Lockheed Martin (defense weaponry), you will see that this is a nation that likes getting drunk, roaming around, eating like an emaciated animal, all with the option to blow things up. You can see it in the profits of these companies, driven by consumer demand, that increases each year. The long-term money is often made by recognizing how humans truly are, rather than what we want them to be (that’s why socially responsible funds don’t pan out, usually).

There are moral theories out there that also hold those accountable who facilitate harm, under the “don’t hand a suicidal man a gun” theory whose origins get traced back to Thomas Aquinas. Is the world a better place because cigarette peddlers exist? Is it a better place because Ray Kroc brought cheeseburgers to the masses? That’s a harder argument to make–the world isn’t filled with scores of people saying, “Thank God I started smoking cigarettes. That’s what really got my life together.” Or “My wife never would’ve gone on a first date with me if I didn’t eat at McDonalds every day.”

On the other hand, a large reason why 401(k)’s, pensions, and so on have done so well over the past 20-50 years is a result of the strength of Big Tobacco. Over almost any super-long period, the old Philip Morris had long-term returns of almost 20%. Given its longevity and super outsized returns, my guess is that the 10% annual return figure that large-cap American stocks provided from 1926 through 2006 would be noticeably lower without the inclusion of the tobacco stocks.

Imagine a thirty-year old that bought $10,000 worth of the old Philip Morris in 1970. Today, he would have shares of Altria, Philip Morris International, Kraft, and Mondelez worth over $35 million. Short of finding Warren Buffett in Omaha, there are almost no other ways that someone could come up with that kind of wealth today without tobacco investing. If he decides to cash those chips in and set up a $30 million charity that provides a warm shelter for the homeless during the winter months (leaving the other $5 million for himself, his spouse, and kids), then all of those people that are provided a warm dwelling for a night will have smoking cigarettes to thank. Sure, the people sleeping at or working at the shelter may never know this fact, but the person who sets up the charity will go to his grave knowing that his good mark left on the world was built on the back of tobacco smoking.

And you can’t really say: “Oh, just buy other good investments.” Take something like Procter & Gamble–since 1970, a $10,000 investment would have grown into $1.7 million. That is worlds apart away from $35 million. The difference between 12.5% and 20.0% compounding over large periods of time is enormous. The old guard tobacco companies have historically created staggering wealth unmatched by almost all peers, thus creating a greater capacity to do good for those who own their stocks.

You may not think that tobacco serves a useful function in the economy, but it has given so much wealth to its long-term owners over the years that, if they decide to use those funds for charitable pursuits, they would be able to accomplish a net good almost unparalleled by any other prospective investment. If tobacco didn’t exist, the avenue to turn $10,000 into a $30 million charity within 44 years would not exist. There’s no other large-cap opportunities that have performed as well as Big Tobacco.

If I wanted to bring purity to my investment decisions, I’d probably be relegated to trying to buy real estate and living off of those rents. Even then, I’d probably have to get a door knob manufactured by General Electric, and they have polluted the atmosphere and created nuclear reactors with unstable designs, putting the lives of millions at risk were it not for government oversight. And what if I have a couple guys over to help paint the rental house, and I get some SABMiller beer products to drink in between finishing rooms? Well, Altria owns 27% of SABMiller, so I’m back to supporting Big Tobacco again. Up until somewhat recently, any time you ate an Oreo cookie you were supporting Big Tobacco.

With all those things said, there are two excellent firms (from a business perspective) whose stock I would never want to own. So yes, personal morality does come into play. One is a company that is dedicated to outsourcing–removing “high-cost jobs” from the United States and shipping them overseas, and I don’t really want to be a part owner of a company whose purpose is to gut out our country. Additionally, there is a large agricultural firm that has possibly the worst business ethics I’ve ever seen, using litigation as a bullying tool, lobbying Congress in a way unmatched by any peer in a way that comes at a great cost to society, and is so secretive about its unethical business practices that it would likely be an outrage on par with Upton Sinclair’s “The Jungle” days if the full extent of what they have done were to ever see the light of day. So I’ll go about life without owning them.

A lot of times, public forums about moral investing turn into a game of calling each other a hypocrite. “You won’t buy a company that raises the rate of unemployment–I’d rather be unemployed than dead if I smoked cigarettes!” And then the other person will say, “I’m an adult that knows about the health consequences of cigarettes, and any time I smoke, I choose to do it. You don’t have much of a choice when it comes to getting laid off from a job.” A lot of people shy away from writing those types of articles because it turns into a circus, and most of the dialogue afterwards is filled with negative energy.

I get why people don’t buy tobacco stocks. Almost everyone has been negatively impacted by tobacco in some way. On my dad’s side of the family, no one had to make my grandfather breakfast because “he could light his own damn cigarette.” It’s very likely his life was cut short a few years because smoking 2-3 packs per day for 60 years is not the key to longevity. If every dollar he spent consuming tobacco had been used to buy the stock of the old Philip Morris, he would have had a $140 million fortune, a net worth higher than the combined salaries of every member of the 2013 St. Louis Cardinals (his favorite baseball team).

Warren Buffett said he drinks 5 Cherry Cokes per day and frequents Dairy Queen regularly. At one point in his life, he ate a lot of doughnuts, which we’ll assume were manufactured by one of the baking divisions under the Berkshire umbrella. If you buy Berkshire Hathaway stock, you are buying interests in those cheeseburgers, sodas, and doughnuts. Who dies first: the guy who wakes up, eats a cheeseburger and fries, has a couple doughnuts, and drinks soda all day, or the guy who smokes? I can’t see a huge difference between the ethics of either.

Morality with investing is a tricky subject–the Big Oil companies like Exxon, Chevron, and Conoco are not particularly popular with the American public. Yet the highest quality people, in terms of character and intelligence, that I knew at Washington & Lee when I was in college, went on to become petroleum engineers. Oil stocks have provided pension and 401(k) income for almost a century, and paid the taxes used to build our roads, national defense, and general needs of our country.

If you study any company hard enough, you will find things you don’t like. If you react the same way to Altria, Lorillard, Reynolds, or Philip Morris as I do to the agricultural or outsourcing firm that I studied, then it makes sense not to buy. In a $15 trillion economy, you can find ways to make money without hating yourself. But if you are looking for purity, I don’t think too many S&P 500 companies will pass the test. Worrying about the ethics of companies doesn’t have much of a desirable payoff–after all, you can boycott Altria all you want, but someone is going to own those 2,000,000,000 shares. The best use of energy seems to be focusing on the good you can do with the wealth you acquire: I’d rather spend 1,000 hours working and doing something productive that has a direct benefit on the community I live in, rather than spend that time studying the nooks and crannies of American companies, looking for reasons to cross them off my potential investment list. If your life’s purpose is to create high-impact good, then working and doing something intelligent with the wealth you build is where I’d devote the overwhelming bulk of my energy.

By the way, Joe, you win. I’m running late to the Super Bowl party I’m attending because I got so caught up focusing on your question. Well done.