This article is part of a Real Money series on a dozen companies investors should consider adding to their watch list of so-called "vice stocks."
Paul Coughlin's first analysis of what he calls "live-for-today" companies was in 2013, when his private-equity firm, Longroad Asset Management, was considering buying Maxim magazine.
While mulling over the deal, Coughlin thought about building a pure-play lifestyle portfolio of stocks that would capitalize on Maxim's branding, and he was shocked to find how well certain consumer brands -- those often referred to as "vice stocks" -- were performing. (Maxim was later purchased in February 2014 by Biglari Holdings in a private exchange.)
"So I ran all the SIC (standard industrial classification) codes and we back-tested it and the numbers were crazy," he said in a Thursday interview with Real Money. "That's when I started to formally put together a track record."
Today, Coughlin's global-consumer-brand portfolio is geared to about a dozen stocks tied to alcohol, firearm and tobacco companies, and is posting impressive numbers. Last year alone, the portfolio booked a gross return of just over 25% vs. a modest dip in the S&P 500.
Part of the portfolio's success, according to Coughlin, is that the brands have engendered very strong customer loyalty, and in many cases are well insulated from economic downturns as the scope of their products often cover a broad range of income segments.
So, on news of WYNN Resorts' (WYNN) 12% stock surge Thursday, which comes at the heels of a strong earnings beat, Real Money decided to add gambling in the rollout of its own watch list of a dozen vice stocks with upside potential. Among casino operators, Real Money is including Churchill Downs (CHDN) and Las Vegas Sands (LVS), whose shares are up about 29% and 15%, respectively, so far this year.
Firearm stocks also have been hot and tend to rise as political rhetoric heats up around regulation, and will likely gain as campaigning in the this year's presidential election heats up, Coughlin said. Real Money has chosen Vista Outdoors (VSTO), Smith & Wesson (SWHC) and Sturm Ruger (RGR) for its Vice Squad watch list. Smith & Wesson has been leading the charge among the three, with shares up more than 82% over the past 12 months, along with 39% and 12% gains over the period for Sturm Ruger and Vista, respectively.
"We like Vista Outdoors as because they have become a pure play," Coughlin said, noting that since its spinoff from Alliant Techsystems (ATK) last year, the company primarily focusses on the production of ammunition.
Tobacco companies have also posted strong gains over the past year, and Vice Squad members Altria Group (MO) and Philip Morris (PM) particularly stand to gain from proprietary IQOS smokeless cigarettes and the global popularity of their top brands, analysts with Wells Fargo Securities said in a March report.
"Based on our detailed, 10-year analysis of the market potential for the iQOS platform in the U.S., we believe it has the potential to change the trajectory of smoking and both PM & MO have a competitive advantage given iQOS's superior technology, first-mover advantage with commercialization/clinical trials, and ability to leverage the ubiquitous Marlboro brand," the Wells analysts, led by Bonnie Herzog, said. (Phillip Morris launched IQOS in November 2014, a type of smokeless-cigarette technology that aims to be a hybrid between electronic and analog products.)
Meanwhile, Reynolds (RAI), whose shares have climbed 39% over the past 12 months, was also selected for the Vice Squad.
"Once you get outside the U.S., smoking is still rampant, and American brands are obviously the best and biggest," Coughlin said.
In terms of alcohol stocks, Coughlin said that many of the brands have engendered strong loyalty among their customers and are capable of catering to various income levels.
"When the stock market goes up, you're drinking Grey Goose, and when the stock market goes down, you're buying Smirnoff," Coughlin said in an interview with Real Money, which has selected Diageo (DEO), Molson Coors (TAP) and Constellation Brands (STZ) for the Vice Squad.
Constellation is the latest to rally, with shares surging Wednesday on news of a potential initial public offering of its Canadian wine businesses, as well as a quarterly earnings report that surpassed analyst forecasts, as Real Money reported.
"If STZ pursues this IPO, we expect they would sell a minority stake in the business, and raise $0.5 billion - $1 billion in net proceeds, which would likely be used for debt paydown and other capital allocation uses consistent with current priorities," Wells Fargo analsysts wrote Wednesday. Wells maintains an Outperform rating on Constellation, and values the stock at about $180, with its beer business alone accounting for $130 of the price.
"All we're trying to do taking advantage of what people do every day," Coughlin said. "The demand is always there. And my attitude as an investor is you have an obligation to do what's right within the boundaries for your constituents."
Real Money's Vice Squad Watch List
- Diageo (DEO)
- Molson Coors (TAP)
- Constellation Brands (STZ)
- Reynolds (RAI)
- Altria Group (MO)
- Philip Morris (PM)
- Vista Outdoors (VSTO)
- Smith & Wesson (SWHC)
- Sturm Ruger (RGR)
- WYNN Resorts (WYNN)
- Churchill Downs (CHDN)
- Las Vegas Sands (LVS)