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Thursday, May 16, 2013 - 08:30

Profit From Customer Loyalty With These 7 'Sin Stocks'

Thursday, May 16, 2013 8:30 AM

Some investors spend a lifetime searching for the holy grail of investing that will help them find the best companies and opportunities. That quest for a magic bullet has given birth to all kinds of strategies and techniques, from fundamental analysis to day trading.

But sometimes, keeping things simple is the easiest path to success. That's the message that my colleague Elliott Gue, editor of Top 10 Stocks, emphasized in an article last month. Elliott's message is clear: Companies with extremely loyal customers offer huge benefits to investors because the connection that loyal customers have with their favorite brands has a powerful effect on a company's bottom line.

Think about customers who love Starbucks (Nasdaq: SBUX): Drinking Starbucks coffee isn't just about coffee -- it's also a status symbol. The message is "I am smart and successful, and therefore I can afford to spend a lot of money on this cup of coffee."

Loyal customers are also more predictable because they are less susceptible to fluctuations in the economy and employment. In economics, this is referred to as elasticity of demand. That played out for McDonald's (NYSE: MCD) in 2009, when the company's annual revenue of $23 billion was on par with 2008's $23.5 billion while other companies saw revenue plummeting in response to the financial crisis.

Starbucks and McDonald's are world-class brands with extremely loyal customers -- but I've found another group of companies that takes the premise of loyalty to another level.

So-called sin stocks capture the loyalty factor while adding an important layer of devotion: addiction. A beer lover with an affinity for Boston Beer Co.'s (NYSE: SAM) Samuel Adams is unlikely to trade down to during a recession. Similarly, someone who smokes Marlboro cigarettes is unlikely to give up that brand when wage growth slows.

Sin stocks also frequently pay an outsize dividend, another factor making them a great fit for High-Yield PRO. That makes investors loyal to sin stocks in addition to their highly devoted customers.

My seven favorite sin stocks:

From the list, I have chosen to highlight Boston Beer Co. because of its upward momentum and smaller size and Reynolds American (NYSE: RAI) because of its dividend yield.

Boston Beer Co.
One of the country's leading specialty brewers, Boston Beer Co. is known for its Samuel Adams line of premium brews. Shares have been surging, up 35% in the past year and 75% in the past two.

Analysts expect more gains, calling for earnings growth of 11% in 2013 and 13% in 2014. Despite the company's recent gains, shares still look reasonably valued, trading with a PEG (price/earnings to growth) ratio of 1.78, less than its 10-year average of 1.87.

Reynolds American
Reynolds American is a cigarette and tobacco company with a market cap of $26 billion. Its line of products includes such leading cigarette brands as Camel, Kool and Pall Mall.

Reynolds has also been on the upswing, with shares up 12% on the year and 24% in the past two. Although growth projections are modest, with analysts calling for 14% earnings growth in the next two years, Reynolds carries a dividend of 4.9 %.

Risks to Consider: Sin stocks have seen big gains in the past few years as investors have piled into companies paying an outsize dividend yield. That has pushed valuations above long-term averages, which could trigger a wave of profit-taking if the market shifts lower.

Action to Take --> Loyal customers offer huge benefits to both companies and investors -- and these seven stocks have some of the most loyal customers in the world. From this group, I particularly like Samuel Adams because of its upward momentum and Reynolds American for its dividend yield.

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Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of PM, MO in one or more of its “real money” portfolios.