In Part 1 we explored how to determine if you’re invested in tobacco, why it matters, and what you can do if you are. Here in Part 2, we’ll try to answer the question of whether investing in tobacco, which we know is harmful to people, is good investing.
Before I became a finance professional, I thought figuring out what was a good investment required some sort of mysterious wizardry involving risk and ratios and balance sheets and…I give up! All that stuff is useful and important if you’re trying to decide between Philip Morris and Marlborough. The good news is, this exercise isn’t about stock-picking, it’s about a whole industry and a little bit of logic, a few good questions, and maybe a bit of help from Google will get you a long way. Here’s how I think it through.
What do I already know about the tobacco industry?
Well…for starters I know that I don’t see nearly as much smoking around me as I remember from when I was a kid. In most of the US smoking is banned in many public spaces. I also know from reading the news that taxes keep rising on cigarettes and that restrictions keep increasing on where, how, and to whom they can be marketed and sold. Finally, I know, also from reading the news, that there have been some big legal settlements against tobacco companies.
So what does that all mean? Well, the various smoking restrictions certainly make me wonder whether smoking is declining. A quick Google search for “smoking trends” confirms it is1 and if smoking is declining, presumably cigarette sales are, too. The legal settlements might have had a short-term impact on returns, but from an industry-wide long-term perspective my hunch is they don’t matter that much. If I’m wrong, logic suggests they would reduce returns.
But aren’t tobacco companies global?
Absolutely. Tobacco companies are global, so maybe it doesn’t matter that much if US cigarette sales are shrinking. Let’s find out. A few more minutes with Google (still searching for “smoking trends”) tells me that smoking rates seem to be declining in most of the world, although there are parts of the developing world where they’re growing.2 Aha! Those smart tobacco companies have probably done just what I’d do if my biggest market went bad — they went looking for new markets and they seem to have found them. But will the growth continue? Here’s where a little logic comes in.
The cat is out of the bag. Smoking kills. People in the developing world probably aren’t any more excited about dying an unpleasant death from lung cancer than I am and their governments probably aren’t any more excited about picking up the costs than ours is. As education levels and income rise and with the rapid penetration of smartphones, it seems highly unlikely tobacco companies will be successful in maintaining growth in these markets for very long. Furthermore, most of the countries where smoking is on the rise are fairly small so growth is limited by population size.
Well what about new technologies like e-cigarettes?
When expanding the market for your existing products fails, it’s time to find new products and that’s certainly what the tobacco industry has done. Another quick Google search (“e-cigarette sales”) quickly turns up reports of a CDC study that show sales rising rapidly.3 But in the same article I also learn that the Food & Drug Administration (FDA) is scrutinizing those products and it sounds like increased regulation and enforcement are imminent. Do I really believe that e-cigarettes are going to rescue the industry? Personally, I don’t. I think they’ll get a short-term boost and then the evidence will pile up that e-cigarettes are also dangerous and the regulatory, educational, and financial methods that have worked to curb smoking, will be deployed against e-cigarettes, too. Unless the industry can develop a replacement that has none of the health risks of smoking, it seems unlikely that incremental innovation can prop the industry up indefinitely.
So, is it a good investment?
I don’t have a crystal ball. Maybe tobacco companies can reinvent themselves and their products so effectively that they’ll succeed, but it doesn’t seem very likely to me. You have to look hard these days to find someone who isn’t aware that smoking is bad for them and the world is primed to scrutinize new tobacco products pretty carefully. New technologies may give the industry a short-term boost, but unless they really prove harmless, will likely have short growth cycles. If you’re investing for the short-term, you could see decent returns, but the industry seems structurally unsound for long-term investing.
Disclosures, Definitions, and Footnotes
1. US Centers for Disease Control, https://www.cdc.gov/tobacco/data_statistics/fact_sheets/adult_data/cig_smoking/index.htm, last accessed 8/19/2019.
2. World Economic Forum, https://www.weforum.org/agenda/2016/06/5-charts-that-show-the-global-state-of-smoking, last accessed 8/19/2019.
3. NBC News, E-cigarette sales soared as prices fell, CDC study finds, August 2, 2018.