The personal finance world hates payday loans more than your stinky grandpa hates to shower. Seriously, Grandpa, we’ll get you one of those shower chairs. This shouldn’t be hard.
We all know why. The interest rates are too high. They do bad stuff like calling people at work and charging them outrageous overdraft fees. Even employees hate the business, which is actually ran by Satan himself. You wouldn’t know it because he cleans up nice when going to work.
In theory, the payday loan business should be spectacular. If you’re getting returns of 20% per week on your money, that works out to 1,040% per year. Yeah, there are write-offs and expenses and company hookers and whatnot, but you can afford a lot of that stuff when charging triple digit annual interest rates.
And yet, the payday loan business kinda sucks. I took a closer look at the financials of some of the big U.S. payday lenders back in 2013 and found that, on average, they weren’t really that profitable. Many of them weren’t even completely in the payday lending business either, augmenting the top line with things like pawning and subprime auto loans.
There isn’t really a Canadian publicly traded payday lender after The Cash Store went to zero. A company called goeasy (TSX:GSY) bought the corpse of The Cash Store, converting the locations into something very close to payday loans under the Easy Financial banner. These guys offer loans at a 46% APR with extras like layoff insurance heavily encouraged. They’re better than payday loans, but not much.
At least goeasy (yes, that’s how they spell it, like morons) is nicely profitable. In the last year, the company did $26 million in earnings off of $316 million in revenue. Net profit margins of 8.2% are actually pretty good in this business.
But at the same time, those kinds of margins pale in comparison to some businesses. Take Information Services Corp (TSX:ISV), which runs the land titles registry for the province of Saskatchewan. Over its last 12 months, it did $16 million in net income on revenue of $82 million. That’s good enough for a net profit margin of 19.5%. That’s in a down year too. When Saskatchewan was booming in 2014 net margins were 22.5%.
Why are there so many people clamoring about reining in companies like goeasy and its 8.2% net profit margins when the people who buy a house are clearly being taken for a worse ride? I guess homeowners can afford to pay more than the average dirtbag borrower. (Helen Lovejoy voice) Oh won’t somebody think of the homeowners!
This brings me to the point of this post. Why exactly would anyone want to invest in these terrible businesses?
Say you’re looking for financial exposure in your portfolio. You have a choice between goeasy and one of the big banks, say Bank of Nova Scotia. Sure, BNS shares have some risk–the energy-related loan book and exposure to insanely high real estate markets jump out as big ones–but at least you know you’re not investing in a company everybody literally hates.
BNS is also more way more profitable than goeasy, boasting profit margins of 27.2%.That’s because it can use way more leverage than goeasy, and it has far better growth prospects. It’s easier to grow a bank than a specialty lender 95% of the population treats like herpes.
Which would you rather own? I’m a contrarian at heart and I’d still take Scotiabank over goeasy six days a week and twice on Sunday.
Here’s an incomplete list of businesses that people legitimately hate:
- Payday loans
- Loan sharks
Your mileage will vary, of course. Some people have problems with all of those things, others don’t bat an eye at any of them. But the fact remains that every one of those businesses suffer from some sort of social stigma and that will affect any stocks in the sector.
There’s really only one legitimate reason to own a sin stock, and that’s if it’s a great value compared to other investments. This value can be realized in one of two ways, either via a price-to-book value discount or a price-to-earnings discount.
Say goeasy traded at half book value and six times earnings. That stock would be insanely cheap, especially in today’s expensive world. It would likely be worth the risk because it trades at such a discount to other stocks.
But these days, goeasy trades at about 10 times earnings and 1.5 times book value. That doesn’t seem very expensive until you realize it’s only a little cheaper than the big banks. Thus, investors aren’t getting compensated enough to own it. There’s no reason to take the risk when it’s only a little cheaper than its peers.
Tobacco might be the greatest business known to man. It takes a little capital to get going, some clever marketing, and that’s really about it. People are addicted to the product (up until it kills them, anyway), they’re generally pretty brand loyal, and we can always count on a new generation of smokers to take over for the old ones.
Except that new generation gets smaller every year as even the stupidest kids elect to not light up. There’s still litigation risk affecting the big tobacco companies, and they trade at greater than 20 times earnings. As far as I’m concerned, investors aren’t getting compensated well enough for these risks.
There’s money to be made buying so-called sin stocks, provided you’re patient. But in most of these types of businesses, you’re best to just not bother. Stick with stocks everybody likes until an unbelievable opportunity comes along. Finally, peer pressure works.