Measured Progress
Friday, April 20, 2007
It’s no secret how Wall Street looks at a stock; most investment banking analysts play some version of the same numbers game. They gin up models of a company’s financial drivers, then plug in data based on what they know or can guess about revenue and spending. The spreadsheet spits out projections of future cash flows and profits, which imply a certain valuation.
The problem, of course, is that there’s much more to corporate performance than what we can glean from traditional financial reporting. Any company creates impact across multiple realms. Its products and services can improve customers’ health and welfare, or not. Its workplace practices have consequences for the wealth and well-being of employees. Its activities touch the community and the environment, for good and bad.
Over the long term, arguably, these nonfinancial dynamics shape a company’s performance as surely as any financing strategy or marketing plan. They can be a source of risk, or of competitive advantage. But as investors, most of us are still conditioned to accept a myopic view of corporate purpose: A company’s role is to generate financial returns, period. Even if we didn’t buy that, the social impact of businesses has always been insanely difficult to measure. So rather than do all that messy research, we’ve tended to look the other way.
But what if we agreed that short-term profitability doesn’t guarantee long-term investing success? And what if we could measure those nonfinancial returns? Then the game changes in some pretty profound ways.
More and more, investors are actually asking how companies treat their workers, what levels of greenhouse gases they emit, which patents they’ve filed for, and many other questions that can’t easily be answered by quarterly earnings reports. One indicator: In 1995, some 55 socially screened mutual funds had $12 billion in assets, according to the Social Investment Forum. A decade later, such funds numbered more than 200, with $179 billion in assets. It isn’t only the Whole Foods crowd taking heed: More than 100 investment managers and investors, representing $5 trillion in assets, have signed on to the Principles for Responsible Investing, introduced by the United Nations last year. “Environment, social, and governance issues are now commanding dramatically more attention,” Goldman Sachs chief U.S. investment strategist Abby Joseph Cohen told attendees at a sustainable-development conference last year.
That demand has fueled (and funded) the creation of a sort of shadow research industry consumed with both pinpointing nonfinancial metrics and linking those measures to financial performance. It’s populated by folks such as Swiss serial entrepreneur Peter Ohnemus, whose upstart firm, Asset4 (backed in part by Goldman Sachs, offers institutional investors more than 250 indicators that cover both economic and so-called extra-financial characteristics of the nearly 1,500 companies it covers. Ohnemus’s goal: “We want to be the Bloomberg of extra-financial data.”
He’ll have competition. In 2004, European asset managers and pension funds formed the Enhanced Analytics Initiative, agreeing to promote nonfinancial measures by steering at least 5% of their broker commissions to firms that incorporate environmental, social, and other factors into their research. That’s fueling demand for research on nonfinancial performance, sustaining a small raft of specialty firms such as Innovest Strategic Value Advisors, IW Financial, and KLD Research & Analytics.
Fast Company has launched its own effort in this realm, teaming with researchers R. Paul Herman of HIP Investor and Sara Olsen of the Social Venture Technology Group to develop an exclusive approach to measuring the human and social impact of businesses. Herman and Olsen surveyed 21 leading public companies on sustainability processes, metrics, and outcomes, combining the results with existing public data.
The result, what we call the HIP (that’s Human Impact + Profit) Scorecard (see chart), provides a tangible guide for investors trying to build nonfinancial metrics into their stock-picking approach. We assessed companies’ progress in developing management practices focused on generating and measuring impact on customers, employees, and the environment. And we estimated the percentage of each company’s revenue associated with sustainable practices.
It’s a potentially powerful approach–but one that also makes plain how difficult this sort of analysis remains. It’s pretty straightforward, for example, to collect information on the breadth of health benefits a company offers its employees. It’s another thing, though, to calculate the actual impact of those on employees’ health–and how that reflects back on the company’s future financial performance.
Even with a lot more resources dedicated to the task than a decade ago, measuring and quantifying so-called environmental, social, and corporate governance (ESG) factors is tricky. Sure, businesses have begun to disclose more information, driven in part by investors demanding more transparency. “There’s a whole movement pushing companies to standardize reporting on ESG and to integrate it within their traditional reporting,” says Jane Ambachtsheer, who heads Mercer Investment Consulting’s responsible-investment practice. But while a handful of companies (like those we surveyed) are eager to share, most haven’t even begun to think about such issues. Beyond that, many intangibles simply aren’t very ? tangible.
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