Green Performance Creates Value and Competitive Advantage

Green Performance Creates Value and Competitive Advantage

We at Winslow Management Company have long proclaimed that a strong environmental record enhances a company’s financial performance. We have also maintained that screening stocks for their “green quotient,” far from jeopardizing the value of an investment portfolio, may actually increase it. Our colleagues at Innovest Strategic Value Advisors, based in New York, Toronto, Paris, and London, have created a highly credible assessment tool that correlates eco-efficiency with financial performance and value-creation potential. No surprise to us, the proprietary EcoValue’21 rating system supports our core assumptions.

Consider, for example, Innovest’s analysis of the semiconductor industry. Applying the EcoValue’21 system to the companies in this sector, the best environmental players were separated from the worst. Then, the performance of the two groups was graphed over a five-year period. Sure enough, the top half’s environmental leaders out-performed the bottom half’s environmental laggards by 46.2%. Innovest’s results also held true over the medium- to long-term in other sectors including electric utilities, retail, real estate, steel, and mining.

Putting the Theory to the Test

In recent years, many financial analysts and asset managers have begun to acknowledge the success of companies with innovative environmental/sustainability programs. And they have lots of questions. They want to know how green performance impacts a company’s future value-creation capability. They want to see whether eco-efficiency gives a company a unique competitive advantage. And they want to know how sustainability initiatives influence entire industries. The answers they want are accurate metrics, not just anecdotal evidence. To address this demand, Innovest spent over three years developing the EcoValue’21 rating system.

A synthesis of qualitative and quantitative data, this tool uses multi-factor algorithms to integrate over 60 data points. On the qualitative side, the system rates a company’s relative ability to manage environmental issues into the future without compromising profitability. It analyzes such factors as strategic corporate governance capability, company-wide environmental management, environmental cost accounting, social issues performance, supply chain management, and stakeholder relations. On the quantitative side, the system measures a company’s potential exposure through the number of Superfund sites, the sector’s historical risk profile, ratios of environmental fines to revenues, concentration of high-risk products in the company’s portfolio, and budget funds allocated to environmental protection and R&D.

The end result is a relative scoring scale, with the best performance within an industry sector given a ten and worst performance given a zero.

Two Sides to Every Story

Innovest’s system computes both the negative and positive environmental factors that can affect companies’ bottom lines. Potential damage arising from neglect or mismanagement of ecological responsibilities includes:
  • Balance sheet risk from historic liabilities
  • Market risk such as damage to the company’s reputation and image
  • Capital cost risk in the form of pollution control expenditures
  • Operating risk from product liability
On the flip side, superior environmental performance can create competitive advantages. Innovest has identified five key areas in which financial opportunities result from environmental innovation:
  • Cost containment from pollution prevention and waste reduction
  • Sales and market share growth from environmentally preferable products and services
  • Franchise value enhanced by a green reputation
  • Stakeholder satisfaction whereby customers, employees, suppliers, regulators, local communities, and other key stakeholders are positively influenced by a superior environmental track record
  • Innovation capacity which spreads to other functions, departments, and corporate players
Through its EcoValue’21 research, Innovest has concluded that outstanding environmental performance, along with “human capital, stakeholder capital and sustainable governance” are among “the most powerful clusters of intangible value drivers” affecting companies’ true worth and competitive prospects.

Winslow Tracks the Smaller Stocks

Though most of the EcoValue’21 research is focused on large-cap stocks and is similar to screening we have done on the S&P 500, we at Winslow have been also working to build an analogous tracking system for smaller companies. Our core research has traditionally been centered on small- to mid-cap stocks, and includes an evaluation of each company’s potential for good financial return and its environmental impact relative to its peers. By building an environmental data bank on smaller companies, we intend to not only maximize returns for our clients, but also encourage green growth in the companies themselves. By opening a dialogue on sustainability, we help introduce some firms to the concepts of eco-efficiency at an early stage, which will likely contribute to stronger environmental and financial performance over time.

We believe that with a proven history in hand, mainstream investors should be able to see (and not just believe) that strong environmental performance is a key driver of highly competitive financial performance.

Celine M. Suarez is an environmental analyst at Winslow Management Company, a Boston-based investment management firm specializing in green investing.

This article was first published in the July 2003 issue of the Winslow Environmental Newsletter.