Are the market's most dubious sectors the most profitable?

Ethical investing is a touchy subject and perhaps one of the most controversial subjects to write about. Whether it be tobacco, oil, arms, gambling or alcohol, many investors will steer clear of these dubious sectors, instead favouring companies which try to be good corporate citizens.

Now, I'm not trying to glorify, or support the tobacco and arms industries. However, figures suggest that over the past five decades or so, the tobacco industry has been the market's best performing sector. Aerospace & Defence has also been a strong performer. Lets take a deeper look.

Second to none

Altria is the owner of Philip Morris USA, the U.S. arm of Philip Morris International. Philip Morris USA and Philip Morris International separated for legal reasons.

Altria has a StockRank of 92 thanks to robust momentum (91) and quality (90) ranks but a low value (54) rank. Indeed, at present levels Altria looks expensive as it trades at a forward P/E of 17.0, compared to the market median of 16.2. The company also has a sky-high price to book ratio (market median: 2.1 vs. MO: 21.1) and price to sales ratio (market median: 2.1 vs. MO: 3.8).

But sometimes you have to pay for quality. Over the past four-and-a-half decades, Altria's (formerly Philip Morris) shares have returned 300,000% including dividends -- that's not a typo. Go back nearly six decades and figures suggest that $1,000 of Philip Morris stock purchased during 1957, would be worth about $5.8 million today, a return of 579,900%.

Philip Morris and Altria have been able to achieve these returns due to their ownership of the infamous Marlboro brand of cigarettes, one of the world's most valuable brands. What's more, cigarettes cost almost nothing to make but can be sold at a huge profit. Altria's operating margin (26.9%) is 400% above the market median (5.3%) and return on capital (23.2%) is in the top 10% of the market (market median 1.8%).

Altria is only responsible for Philip Morris USA. The international operations are the responsibility of Philip Morris International. Philip Morris International has a lower StockRank (84) than Altria due to low momentum (73) and quality (70) ranks, although the company remains attractive on many metrics.

The company, which owns the international rights to the Marlboro brand, has an operating margin of 41.5% and supports a dividend yield of 4.8% at present levels. Further, despite changing opinions towards cigarettes and falling sales volumes, Philip Morris has been able to increase its earnings per share at a compounded annual growth rate of 10% for the past six years. There are not many companies that are able to increase earnings at a steady, double-digit rate, while volumes of the product sold, fall.  

The business of war

Northrop Grumman and General Dynamics are two of the world's largest aerospace and defence companies. Both companies support a leading StockRank of 99.

The two defence giants manufacture one-of-a-kind weapons systems, which means that they have virtually no competitors in certain markets. In particular, General Dynamics manufactures, amongst other devices, the Abrams Tank, Gulfstream private jets and has been manufacturing submarines for the U.S. navy since 1900. Northrop Grumman develops systems and controls for applications across the military and commercial spectrum.

With their reputations behind them, as well as quality products and a lack of competitors, Northrop and General Dynamics have dug a wide moat around their businesses. And with these wide moats the two companies have been able to clock up impressive rates of growth and a strong return on capital.

Northrop Grumman has grown EPS at a CAGR of 22.9% during the past five years as the company's operating margin has risen from 7.9% to 13.3%. Return on capital employed has also increased from 9.1% to 16.2%, compared to the market median of 3.2%.

General Dynamics' performance has been less impressive, with the company's EPS only growing at a CAGR of 2.5% during the past five years. Nevertheless, the company scores well on the quality (94) and momentum (98) ranks with a one year relative strength of 24.9% and an industry leading return on equity (market median: 4.7% vs. GD: 20.4%).

Outperformance

These investments may not be suitable for every portfolio. Every investor is different and has their own goals and objectives. Nevertheless, the performance of these companies over the long and short-term has been stronger than that of their more ethical peers and the wider market.

The Ethical Investment Research Service, or EIRIS for short, has compiled a Global Sustainability Rating list. At the top of the list, companies like GlaxoSmithKline, Roche and Novartis lead, so do FirstGroup and Puma. At the bottom, with some of the lowest scores of the world's top 50 companies are ExxonMobil and Chevron. Of course, big tobacco and defense companies are not included.

In terms of performance, over the past five years, the S&P 500 has returned 88.54%, while General Dynamics has returned 95.8%, Northrop Grumman 151.9%, Altria 163.9% and Philip Morris is the laggard with a return of 77.4%, although these figures are excluding dividends. These returns are all greater than those achieve by companies that top the EIRIS Global Sustainability Ratings. Over the past five years, excluding dividends, Novartis has returned 73.9%, FirstGroup negative 71.3%, GlaxoSmithKline 13.6% and Roche 79.7%.

The bottom line

As usual the information within this article should not be taken as investment advice, neither is it supposed to advocate, glorify, or support the tobacco and arms industries. However, the figures do suggest that over the long-term sector leaders within in the tobacco and arms industries have outperformed the market. This trend has been supported by their wide moats and market leading profitability metrics. If you have any ideas or reflections on the above information, the StockRanks or informative insights, please leave a comment below. 

Disclaimer: Of the companies mentioned, Rupert owns shares in Altria