The Top-Rated Sin Stocks

"Sin stocks." The very phrase conjures up either excitement or disdain. Tobacco, alcohol, gambling, and defense can be polarizing, and they're generally topics to avoid at dinner parties, so it should come as little surprise that investors have equally strong opinions about companies in these trades.

Proponents of socially responsible investing (SRI) will argue there are simply healthier and more ethical ways to invest your money than in sin stocks. Fortunately for these investors, there are funds like the Vanguard FTSE Social Index (VFTSX) and Domini Social Equity (DSEFX), specially designed for those who want to rid their portfolios of sin and vice.

One man's garbage ...
On the other hand, SRI's intentional avoidance of an entire sector of the market could provide outsized returns for sin stock investors. In fact, Wharton professor Jeremy Siegel found that between 1957 and 2003, Philip Morris (now Altria (NYSE:MO)) was the best-performing stock on the market.

One of the reasons for Philip Morris' outperformance, Siegel argues, is that investor aversion to the company's business of tobacco-mongering kept share prices down, thus raising the return for investors who stuck by the stock. His point is that earnings growth alone matters less than earnings growth relative to market expectations in driving stock prices higher. Because investors were frequently concerned with Philip Morris' litigation liabilities and reduced tobacco use among the public, they frequently underestimated the company's actual earnings growth.

The Vice Fund (VICEX), which invests only in tobacco, alcohol, gambling, and defense stocks, employs a similar philosophy, and so far the returns are intriguing. Over the past five years, for example, the Vice Fund has returned 14% annualized, while the Vanguard FTSE Social Index and Domini Social Equity funds have posted just 5% and 6% annualized returns, respectively, over the same period.

Laugh with the sinners
Over on the Motley Fool's 115,000-member investing community, CAPS, the sin stock debate rages on. You can join the debate by clicking here, but first consider the top-rated sin stocks on CAPS:

Source: Yahoo! Finance and Motley Fool CAPS, as of Aug. 8, 2008.

Will any of these companies be the next Philip Morris? Maybe, maybe not, but each has been given a five-star CAPS rating, and we've found that five-star CAPS stocks have outperformed the market as a group. That could be reason enough to do more research on these stocks. Click here to start your research on CAPS.