Environmentally friendly companies trade at much higher valuations than those failing on this metric, Schroders has claimed.
Referencing its SustainEx tool, Schroders found a 'good' company (one that is highly environmentally friendly) would be worth roughly 50 per cent more than a bad one with the same earnings.
Using its SustainEx, which looks at the dollar-value of the impact individual companies have on society before scaling this relative to their sales, Schroders found bad companies were valued at 17-times their last 12-months earnings.
However, good companies were on 25-times.
In its methodology, Schroders split the constituents of the MSCI All Country World Index into four buckets (quartiles) for SustainEx - worst 25 per cent to best 25 per cent - and found the story was much the same for forward price to earnings, or the price to book valuation multiples.
It costs more to invest in the cream of the crop.Duncan Lamont, SchrodersDuncan Lamont, Schroder's head of strategic research, said most of the value-add came through the environmental channel.
"Companies with top quartile outputs for the environmental metrics within SustainEx trade on much higher valuations than those in the bottom quartile. Differing social risks result in smaller differences," he said.
He added: "It is also interesting that companies which are in the top quartile for SustainEx overall trade on higher valuation multiples than those in the top quartile for the environmental or social metrics individually.
"This poses an intriguing possibility. There may be an additional valuation premium on offer if a company can be great across a wide range of sustainability criteria, rather than, for example, environmental considerations alone."
The findings should please ESG investors whose objective it is to make it more expensive for 'bad' companies to raise money, and cheaper for 'good' ones to do so, hence making it more difficult for them to trade and forcing change.
But for those most concerned about returns this may be less welcome, said Lamont.
"It costs more to invest in the cream of the crop. The 'sin-spread' between valuations of good and bad companies will eat into any return uplift you may have hoped for based on their differing prospects."
But hope is not lost, he added, as less differentiation between companies based on social credentials suggests that investors focussed on those areas may find it easier to unearth under-appreciated risks.
Sector-based differences
The story is broadly similar across different sectors, Schroders found. But there were also differences.
In all sectors other than real estate, more sustainable companies were found to trade on higher price/earnings multiples than their less sustainably run peers.
This included financial and industrial sectors, where more sustainable companies also traded on noticeably more expensive valuations.
It particularly affected materials companies (23x vs 13x) and energy companies (19x vs 11x).
In the IT sector, Schroders detected a peculiarity in that investors appeared to differentiate quite strongly between companies based on the environmental risks they run but not when assessed across the combined E, S and G criteria.
This was less pronounced in other sectors, it said.
What's more, the market hasn’t really priced in the differing social risks that companies are running, said Lamont.
"Investors are essentially saying that it doesn’t matter to a company’s prospects whether it treats its employees well or if it sells products which cause ill-health (and the financial consequences of such ill-health). Maybe they’re right, but I suspect not.
"These social impacts matter to a company’s sustainable growth rate in the long run. And, if I’m right, then we should see investors start to differentiate more on these grounds in future."
He added: "What is really interesting is that it is only in the past few years that the market has started to pay more attention to environmental risks.
"Before 2017-18 or thereabouts, it didn’t matter as much to investors (at least in aggregate) whether a company was damaging the environment or not. Valuations on good and bad companies were more tightly bunched.
"But there is also evidence that, for many other companies and sectors, the market hasn’t yet held their feet to the fire. Which means there is scope for returns to be earned by researching and identifying the leaders and laggards."
carmen.reichman@ft.com
