Practical analysis for investment professionals
23 March 2017

Selling Sugar Short?

Selling Sugar Short?

One of the most important parts of an investment analyst’s job is identifying long-term trends that will affect a company or industry over a long period of years. This practice is often called “thematic investing.” You’ll have succeeded if you discover that a market favorite is now on the wrong side of technological change or new government regulations. It’s important to be on the right side of a long-term trend.

Changing Tastes

Examples abound of popular companies being surpassed by new technology or new ways of doing business. IBM in the 1970s had an absolute lock on computer technology, so much so that the government expended vast resources on antitrust suits. IBM managed its way through the lawsuits, but when the personal computer was invented, IBM lost control of its customers. IBM had based its market on controlling the decision process of company presidents buying million-dollar mainframes, but when $1,000 PCs were developed, the buying decision was moved downstream to the data-processing managers. These mid-level managers had been scorned by the IBM salesmen and were only too happy to switch to a new brand.

In the 1960s, the retail industry was dominated by Sears. Sears had an elaborate management system staffed with many highly skilled people. When the discount stores appeared in the early 1970s with very lean management teams, Sears couldn’t adapt. Walmart became the leading retailer, boasting astonishing growth for a 20-year period. Now, Walmart has gone flat because Amazon and other online retailers have revolutionized the industry.

When I started in the business in the early 1960s, the largest holdings in our portfolios were electric utilities stocks that offered a combination of well-covered dividends and above-average growth. I remember discussions with analysts as to whether Commonwealth Edison would grow at 6% or 6.5% over the next 10 years. It seemed like an important topic at the time. When government regulation pivoted away from allowing consistent returns on capital, it became a much more volatile environment. Electric utilities were downgraded from stable growth to very cyclical companies, and the industry became much more difficult to follow.

Two other trends started in the 1960s. My boss’s wife came back from the grocery store once with some bottles of a hot new product called Diet Rite Cola. After taste tests, we bought a lot of Royal Crown Cola stock. The stock was a big winner. Furthermore, it was an early signal of a low-calorie food trend.

In 1964 — seven years after the American Cancer Society made the announcement — the Surgeon General announced that smoking caused lung cancer. The anti-tobacco movement was born! After getting medical opinion on board, it was time to inform the public and develop a popular movement. Once popular opinion was organized, government regulators and Congress finally moved. Actions included high-cost excise tax, restrictions on advertising and product labeling, and class-action litigation.

Because the tobacco companies were large and profitable — everybody smoked cigarettes — a titanic battle took place over several decades to regulate the industry. The tobacco companies defended themselves, but public opinion was against them. Many portfolio managers refused to own tobacco stocks — not because the companies became unprofitable, but because the portfolio managers could not stand the level of public criticism. Today, the incidence of smoking is greatly reduced.

A Bitter Sugar Pill

Social activists currently are using the same strategy that worked with tobacco to go after the sugar industry. Then, it was lung cancer; now, it is diabetes. A century ago, diabetes was a rare disease, but now it is a pandemic. Type 2 diabetes and obesity are strongly linked, and both are caused by bad eating habits. Sugar is considered a primary culprit (see, for example, The Case Against Sugar by Gary Taubes). On 4 January 2017, an important lawsuit was filed by the Praxis Project in collaboration with the Center for Science in the Public Interest (CSPI) against Coca-Cola and the American Beverage Association demanding that they stop their misleading advertising around the consumption of sugar-sweetened drinks. Praxis and CSPI claim that sugary drinks are the number one source of the added sugar in the American diet that causes diabetes, heart and liver disease, obesity, and tooth decay. Current trends project that half of Latino and African-American children will develop Type 2 diabetes in their lifetimes! Unchecked, this would be one of the worst public health catastrophes in history.

Whether or not this particular lawsuit prevails, popular opinion on the dangers of sugar will prevail sooner or later. Analysts might do well to evaluate sugary soda stocks carefully. The same logic applies to children’s breakfast cereals, as major brands may come under attack. When social trends are against a company, investors need to be alert.

The irresistible demand of public opinion has forced universal male suffrage, women’s suffrage, prohibition (and its repeal), civil rights, and anti-tobacco laws. Sugar may be the next big crusade. Investors should keep this in mind when looking at food companies and pharmaceuticals.

This article originally ran in the March 2017 issue of CFA Institute Magazine.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/carlofranco

About the Author(s)
Ralph Wanger, CFA

Ralph Wanger, CFA, is a honorable trustee of Columbia Acorn Trust.

9 thoughts on “Selling Sugar Short?”

  1. Joanne Ott, CFA says:

    Yes, sugar is the next culprit. Evidence of the epidemic in diabetes and obesity.

    When actually was the male suffrage period? Are we entering that now? Curious to know what you are inferring. I may have missed it.

    1. Jesse says:

      *Universal male suffrage

      1. Joanne says:

        How so? In what context? Explain please.

        1. Ray says:

          Joanne, before universal male suffrage only the rich could vote:
          “Property requirements were widespread. Some colonies required a voter to own a certain amount of land or land of a specified value. Others required personal property of a certain value, or payment of a certain amount of taxes.”

          1. Joanne Ott says:

            Thanks Ray for the history lesson. Evolution has its ups and downs, I guess. Male suffrage in the 17th century. You neglected to count the animal kingdom suffrage which extends back to the era prior to the arrival of the homosapiens.

  2. Joanne Ott, CFA says:

    BTW – Here’s the NYT article about JAMA outing the sugar industry.

  3. Joachim Klement says:

    While I agree that sugar is increasingly in the spotlight due to its negative effects on public health I disagree with the conclusion that companies that produce sugary snacks and drinks are bad investments.

    To use the author’s example: while IBM and other IT leaders of the 1970s were overtaken by a new generation of tech companies, tobacco companies have done remarkably well as an investment – even during and after the tobacco wars of the 1990s.

    A simple example is a chart of two investments: the five biggest tech companies in 1977 and the five biggest tobacco companies in 1977. The performance over the last 40 years of the tobacco companies has not only been better than the IT companies but better than the S&P500.

    Why is this the case? In my view because the tobacco industry unlike the tech industry did not have to face new entrants. Everybody knew the tobacco I distrust had no future so the existing firms could split the market amongst themselves and had no competition to fear.

  4. J says:

    The author left out a relevant detail in the argument. Soft drink makers transitioned to HFCS from Sugar in the US market in the mid 1980s. High Fructose Corn Syrup is now the primary sweetener for it’s lower cost. Does this information change the strength of the author’s argument regarding sugar’s future price trend?

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