It's Like Stealing Money Legally

In November 1998, cigarette companies including what are now Reynolds American (NYSE:RAI) and Carolina Group (NYSE:CG) agreed to a settlement with 46 states. As part of that settlement, the companies agreed to pay somewhere in the neighborhood of $246 billion over 25 years.

Theoretically, that money was supposed to be used to pay restitution for the state-funded health-care costs of smokers and to discourage tobacco use among kids. In reality, as the map on this page shows, most of the states have diverted a large chunk of the revenue from that settlement to other purposes.

The real-world consequence of taking all those billions of dollars and spending them as general funds essentially means that the states became business partners of the tobacco companies. Not only that, but those states have the full coercive force of The Law at their disposal. That creates a Faustian bargain that essentially assures that smoking will remain legal and the tobacco companies profitable, no matter the true consequences. After all, the states need money, and a "sin tax" on smokers is far more politically palatable than an income tax on all potential voters.

So what?
With so many politicians' careers relying on cigarette settlement payout revenues, it should be obvious that cigarette companies have been great investments. In fact, as this chart shows, cigarette companies -- pretty much as an industry -- have trounced the S&P 500 since the settlement was reached:

Unfortunately, we can't transport ourselves to the past and buy cigarette companies at the time of the settlement. What we can do, however, is learn from that experience and understand how to profit from similar occurrences in the future. The right lesson, of course, is that most politicians are smart enough to not kill the goose that lays their golden egg. In other words, if an "obesity tax" against fast-food giants like McDonald's (NYSE:MCD) ever passes, it'll more or less help assure those companies' successes for decades to come.

Profit from the ugly truth
Fortunately, this story does illustrate a more general investing principle that we can use to our advantage far more frequently. Simply put -- bad news won't necessarily sink a company. All politics aside, whether it's earnings that came in below estimates or a major product recall, if a business will likely survive the blow, you will probably have a chance to profit. The time to buy, in fact, is often when things look their worst. After all, that's when most ordinarily rational people have been scared out of a company's stock, likely sending it down far below its true worth.

At Motley Fool Inside Value, we're not afraid of bad news. We've learned the harsh lessons of history. We understand that your best chance of buying a dollar's worth of value for a significant discount depends on otherwise rational investors being spooked out of their holdings. After all, nobody is going to willingly trade you their $1 bill for a mere two quarters, unless they think their greenback is a fake. Join us today for a 30-day free trial to start spotting those authentic bargains hiding among the nastiest-sounding headlines. Once you learn to look beyond the headlines from the business and focus on the true consequences of the news, your portfolio will thank you for it.

Fool contributor and Inside Value team member Chuck Saletta notes that his property taxes for the local public schools keep going up, in spite of all the state lottery money that was supposed to help foot the bill. At the time of publication, he did not own shares of any company mentioned in this article. The Fool has a disclosure policy.