Call them sin stocks if you like, but investments in guns and cigarettes can be very profitable. If you'd bought shares of Philip Morris International (NYSE: PM)-- parent company for all non-U.S. purchases of Marlboro cigarettes -- when it was spun out of Altriain 2008, you'd be sitting on a tripling of your investment.That performance is well ahead of the broader market.
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And if you'd decided to put your money behind American Outdoor Brands (NASDAQ: AOBC) -- back when it was known as Smith & Wesson -- you'd have an even more stellar return: 284%,to be precise.
Image source: Getty Images
But while it's fun to look back at what could have been, the stock market is a forward-looking entity. While it's impossible to tell you with 100% certainty which of these two is a better stock to buy today, viewing the matchup through three different lenses will help us figure out which company you'd be more comfortable putting your own hard-earned cash behind.
Sustainable competitive advantages
There is nothing -- and I mean nothing -- more important to study than a company's sustainable competitive advantage. Often referred to as a "moat" by investors, this represents what makes a company special, what keeps customers coming back year after year, and what keeps the competition at bay, decade after decade.
Established brands lead to repeat purchases and have stood the test of time, which means they have very solid moats. While Philip Morris has several different brands of cigarettes, none is more important than Marlboro. The single brand accounted for 35% of the company's shipment volume in 2016. Its users are strongly attached to the brand, allowing Philip Morris to pass on incremental price increases to consumers who are more than willing to continually pay up for its addictive products, over and over again.
While American Outdoors also has an iconic brand -- Smith & Wesson -- it doesn't benefit from the same repeat purchases Philip Morris does. In fact, the company recently changed its name to focus on how it was trying to meet more than just the gun needs of rugged outdoor enthusiasts. The company's acquisitions of knife-maker Taylor Brands and camping specialist Ultimate Survival are evidence.
However, it's still far too early to tell if these additions will significantly widen American Outdoor's moat. Given that cigarettes are almost daily purchases -- as opposed to far more infrequent gun buys -- the edge here goes to Philip Morris.
Winner: Philip Morris
Here's where we really start to see a big difference between the two companies. Philip Morris is valued at $162 billion, while American Outdoor clocks in at just $1.2 billion. In other words, Philip Morris is 135 times the size of American Outdoor.
We need to keep that in mind when evaluating the strength of each company's balance sheet. And that strength is far more important than most investors give it credit for. That's because all companies will experience tough financial times at one point or another. With these two in particular, legal and political winds can play a heavy role in both investor and (especially with guns) consumer behavior.
Companies that have lots of cash and not too much debt can emerge from such situations even stronger. They can outspend their rivals to gain market share, buy back shares on the cheap, or even make acquisitions. Debt-heavy companies are in the opposite camp, forced to narrow their focus just to make ends meet.
Here's how Philip Morris and American Outdoor stack up in terms of financial fortitude. And pay close attention to the fact that one's numbers are stated in billions, while the other is in millions.
Data source: Yahoo! Finance. Cash includes cash and short- and long-term investments.
Let's unpack this. Relative to each company's market cap, American Outdoors has a far stronger balance sheet. The company has almost the same amount of debt, but almost twice as much cash and net income, while sporting over three times as much free cash flow.
One of the reasons for American Outdoor's situation is that it has a low valuation. (More on that in a moment.) With the election of Donald Trump as president, many assumed that the fever pitch to buy guns would die down. In some ways, the possibility of a Democrat in the White House was very good for American Outdoor's short-term results. With Trump winning, there isn't a perceived threat to gun ownership.
The bottom line: Buying share of American Outdoor right now means you get a company with a very healthy balance sheet.
Winner: American Outdoor
Finally, we have valuation. While this isn't an exact science, there are some straightforward metrics we can consult to give us an idea of how expensive each stock is.
Data sources: Yahoo! Finance, E*Trade. P/E represents figures from non-GAAP earnings.
If you're a dividend investor, then American Outdoor isn't for you. However, on just about every other metric, the gunmaker beats Philip Morris.
Because of the aforementioned political winds, many investors believe that the gun-buying frenzy will be put on hold for at least another four years. That dynamic allows you to buy shares of American Outdoor at a steep 75% discount to Philip Morris on a price-to-earnings-growth basis.
Furthermore, while Philip Morris' 4% dividend is awfully tempting, it's worth pointing out that it ate up 92% of the company's free cash flow over the past year, putting its long-term sustainability in question.
Winner: American Outdoor Brands
The winner is...
So there you have it: American Outdoor comes out ahead. The company's balance sheet and valuation are far better than Philip Morris. Having said that, if you're a lower-risk investor, the combination of Philip Morris' strong moat and its dividend may mean it's a better fit for you.
Over the long run, sin stocks aren't my cup of tea, but I will admit I'm interested to see where American Outdoor's stock is three years from now, given its bargain-basement valuation.
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