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Is Sustainability influencing companies’ valuation?

November 8, 2017

 

At present, the attention of the mainstream is largely focused on the areas where sustainability (or ESG factors - Environmental & Energy, Social Responsibility and Governance) proves to be an important factor affecting a company’s revenue, growth, margins, required capital and risk. 

 

According to a recent study that examined several hundred cases of ESG impact on sales growth, margins, weighted average cost of capital (WACC) and target price, sustainability on average now accounts for 7% of a company’s valuation. The same study demonstrated that innovation management, corporate governance, supply chain and human capital management were found to be the most important issues.

 

It has also been shown that sustainability has a large impact on profitability, in particular factors such as good human capital management, which leads to lower turnover; excellent operational management and energy efficiency; good sales growth and supply chain management. Steady streams of information confirm taking sustainability into account and applying ESG principles is beneficial to both investors and companies.  As ESG factors are incorporated into investment analysis, companies have started to view environmental and social initiatives as contributing directly to their economic performance.

 

However, recognizing when investors are actually driving a conversation about sustainability with corporations can be difficult. The 'E' and 'S' factors are currently still externalities, that are not priced in yet but will be once regulators and stakeholders internalise these costs. For example, at the moment, climate action is an issue that is not recognized by the mainstream; this means that it does not contribute to the valuation of a company. The valuation should reflect the issues more, once regulations kick in and companies are required to integrate and internalise the costs (e.g. via a Carbon Tax). This could translate into an opportunity to buy a company that is actually mispriced - priced lower than it should be - particularly in developing countries where markets are inefficient (e.g. not capturing all information due to a lack of transparency).

 

It is important to remember that stock prices are ultimately driven by demand; so if more investors take sustainability into account, this will drive stock prices up.

 

Nadia Provenza

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