A recent study by Merrill Lynch found that “good companies can make good stocks,” though not as a stand-alone metric. It’s a good start.
It turns out that high ratings for environmental, social and governance practices, called “ESG,” evidence lower stock price volatility and declines, even if those companies don’t always outperform their peers; in fact, their stock prices do worse compared to others in healthcare, tech, and consumer products.
Why the disconnect? I say it’s all a matter of definitions.
Sustainability means no consumption of resources that can’t be replaced, and no waste of materials or human talent. It defaults to simpler, local solutions over complex, distant ones, since the former are easier to develop, replace, and therefore represent lower risk.
Sustainability means lower investments spent over shorter periods of time, thereby yielding returns faster and more reliably. Once operational, lowering net inputs and outputs from factories means fewer variables that can be disrupted by weather or politics.
Sustainability is a set of business practices that contribute to businesses being more profitable as well as reliable, especially when you add all the cost savings that should come from nixing the maintenance and insurance of practices that are less so.
ESG metics get confused because they confuse these “good” actions with being a “good” company.
Most ESG ratings value marketing campaigns that promote sustainable practices, and corporate giving that supports sustainable causes. Company reputation scores, based on what people say about businesses in public opinion surveys, are also included.
If they like how a company “looks,” then it has to be good, right?
These communications variables have nothing to do with sustainable business performance; worse, they can actually reveal activities that hurt it. For instance, the purpose of marketing is to sell stuff, so every dollar spent promoting an idea like sustainability could be considered wasted (unless it’s selling a sustainably manufactured widget or bottle of soda pop).
About the only communications measure that should matter is transparency, and how well-informed a company’s customers and neighbors are about the business; this translates into happier, more loyal, and more forgiving customers (i.e. they’re more sustainable).
Scoring reputation based on how people feel could yield a high score for a company that has successfully hidden or obfuscated the true nature of its business practices, and ding one for honestly and explicitly sharing the facts about its activities.
So, if you stripped out these mushy distractions from ESG ratings, would be results be more useful?
Sustainability isn’t some vague idea or cause that companies should spend money exploiting for its marketing value; rather, it’s a business reality that should be applied to making operations better, faster, leaner, and more reliable.
Companies that do that will contribute far more to making our world sustainable than any marketing campaign or charitable contribution.
My bet is that they’d also be “good” stock picks.