For decades, many investors have put "sin stock" concerns aside in pursuit of investment returns. Take tobacco: everyone is well aware of smoking's dangerous health effects, but many still extol the "virtues" of the sector's steady returns and reliable dividends. Everything from negative public opinion and health campaigns to regulation haven't substantially hobbled these companies' power or performance over the years.
Many conscience-driven investors have avoided this industry, rejecting straight financial returns because they rejected these companies' core businesses. They can feel vindicated now, though. For tobacco companies, the fear is here -- and in a lot of ways, they made their own beds.
According to Euromonitor, cigarette sales in the U.S. have fallen 29.6% since 2004 . The trend continues; a complex layer of formidable forces are congregating to snuff out tobacco use.
One aspect is particularly interesting. Finally, an industry is cropping up that's burning hot and yielding a big cloud of disruption -- one that seems destined for the business and investing history books.
Lost in a cloud of giant cloud of vapor
The e-cigarette and "vaping" industry is the seismic shift rocking an area known for a surprising level of investment stability despite its clear risks.
The combined market for e-cigarettes and personal vaporizers is approximately $3 billion and growing. Wells Fargo's Bonnie Herzog, one of the analysts following and widely quoted in the area, estimates that the e-cigarette market could burgeon to $10 billion in sales by 2017 . Some Wall Street analysts believe that in the next decade, e-cigarette sales will surpass those of traditional smokes.
The changing landscape isn't lost on the tobacco companies, and they're diving in. Even these products are no guarantee; the marketplace is moving at a breakneck speed that will be difficult for the biggies to keep up with.
- Lorillard (NYSE: LO) owns one of the most recognizable e-cigarette brands, blu, which suggests that adult smokers "Take back your freedom." Lorillard's selling the brand, which has 30% U.S. retail market share, to U.K's Imperial Tobacco as part of its hookup with Reynolds America (NYSE: RAI) .
- Vuse is also widely available, with the tag line "Welcome to tomorrow " and a techno strategy. It's no little guy; it's owned by R.J. Reynolds Vapor Co .
- Phillip Morris (NYSE:PM) is throwing its hat into the ring with its MarkTen product.
The indie spirit is far more prevalent than Big Tobacco's offerings in this area, though. In one of the aboveground examples found in many convenience stores, NJoy's marketing angle is that it's independent from Big Tobacco (and claims that it always will be ).
The market is quickly shifting away from vaping products that look like cigarettes. Users are moving to personal vaporizers, or PVs, that give users lots of options as to how and what to vape, and have open, refillable tanks. Think about inhaling through a pipe compared to a straw .
The case for harm reduction
E-cigarettes and related devices don't involve lighters, smoke, or ashtrays. Instead, they electronically heat liquids in tanks; these e-liquids are available in thousands of flavors containing varying levels of nicotine. Instead of smoking, users "vape," which involves exhaling water vapor. So much for second-hand smoke... or any form of smoke or fire at all.
Users claim e-cigarettes help them quit smoking, and while some remain skeptical, plenty of former smokers contend that these products have helped them kick the "analog" cigarette habit.
E-cigarettes and their vaporizer brethren more closely emulate the act of smoking than solutions like nicotine gum and patches, hitting behavioral experiences such as holding something, hand-to-mouth movements, and inhaling and exhaling vapor that looks and feels like smoke. In addition, the fact that they contain varying levels of nicotine can allow users to gradually wean off nicotine.
As far as social responsibility goes, it's a mixed area. Many will find good news in the fact that tobacco companies -- and their stocks -- will lose a lot of traction as people ditch the cigarettes. On the other hand, many say that any products that contains nicotine is dangerous. Having a healthy alternative is a positive for quitting, but as research progresses and some aspects may be harmful, the behavior may simply be "less bad." What we're most likely looking at is "harm reduction."
Some health experts believe they're potentially dangerous, but others contend that anything that gets smokers off cigarettes is a positive. In other words, it would be darn hard to devise a nicotine product that's more dangerous than traditional cigarettes .
Killer tobacco takes aim at small businesses
Small businesses are America's life's blood, and a whole local retail movement is cropping up. Mom-and-pop "vape shops" are opening all over the country, selling the equipment and "mods," as well as huge arrays of e-liquids that are put into the tanks. These shops are hands-on and social, like bars, since customers can sample a variety of vapor flavors. Meanwhile, life hacks are everywhere in modern society, and the wide variety of vaping equipment brings in a major geek factor. Through "mods," users modify their vaping experiences in individual ways, such as size of the clouds they exhale.
Vaping takes the traditional nicotine habit and makes it a whole different ballgame -- and there are reasons to believe it is a healthier one.
That means the industry is also going on the offense. In a mind-bogglingly ironic move, the big companies are beginning to call for regulations due to "health concerns" of e-cigs -- a sure sign of a big industry trying to squash disruptive competition . We all know the tobacco industry fought regulation tooth and nail, but also made regulation an inevitability given its dangerous products and legendary reluctance to voluntarily admit the health effects straight up.
As is the case in many big industries, anti-regulation is great until it threatens its own best interests, so one part of the puzzle is how it may ultimately impact the upstarts in this area. For many consumers, though, regulation or downright bans threaten a product that they truly believe helps them quit smoking.
Going up in smoke
Disruptive innovation generally involves building a better mousetrap. Sometimes, though, the key is building something far nicer and friendlier than a mousetrap, threatening unfriendly products that the biggest, most powerful, and most complacent corporations relied on for their financial returns.
Regardless of whether one looks at these developments on the socially responsible spectrum, this could be an historical situation that could go down in business and investing books. Every investment has risks, but stocks in industries and companies that are viewed as abusive if not hateful are among the riskiest ones out there as the long term plays out.
The tobacco industry always had the socially responsible reason to avoid a place in people's portfolios. Now, though, it's got a financial reason that all investors should think about: a serious competitive threat that's been igniting in the underground.
When there's no love lost between consumers and an industry, they'll make another choice the first chance they get. Devising "better ways" can topple corporate empires. The consumer, regulatory, and even societal component of how industries operate in the world can't be ignored.
The growing trend to put down the cigarettes and go ahead and start vaping is a perfect example of when reputational risk gets real -- and teeters over the edge into widespread consumer revenge.
Check back at Fool.com for more of Alyce Lomax's columns on environmental, social, and governance issues.