Imagine, if you will, a world in which public companies would be rewarded by investors for being well-prepared to deal with climate change.
Investors who look at traditional ways to value companiesâ€” their price/earnings ratios, return on invested capital or revenues per employee — would also calculate how much revenue or profit a company generates for each ton of CO2 emissions. A low Rev/CO2 or Rev/EBITDA ratio would be a sign of risk, evidence that a company would struggle to cope with the higher costs imposed by carbon regulation.
This isnâ€™t my idea, or the brainchild of an environmental group. These â€œgreen metricsâ€ are being put forward by Merrill Lynch in a 40-page report called â€œCombating Climate Change â€“ Opportunities and Risks.â€ The Merrill report argues that smart companies need to get ahead of the curve and prepare for a carbon-constrained world. (I couldn’t find the report online but there’s a press release here.) The report comes from equity analysts Zoe Knight and Asari Efiong, who are based in London. They write:
Corporates are identifying the wider benefits of adopting a proactive environmental stance; namely higher operational efficiencies prior to legislative changes, opportunities to help shape government policy, lower risk from supply chain and workforce disruption, and demand drivers from a â€˜climate awareâ€™ consumer. In effect, the benefits of addressing environmental externalities are beginning to outweigh the costs, with intangible benefits a key driver.
In other words, being green is good for business.
This is not stop-the-presses news. Groups like CERES, the coalition of investors and environmentalists, have pushed companies for years to report on how they are preparing for climate change. Innovest Strategic Advisors, which rates companies on their environmental and social performance, has built an entire business on the idea that environmental strategies matter to investors. DuPont, GE and Wal-Mart have touted their sustainability initiatives.
Still, anytime a long-term issue like climate change gets the attention of Wall Street, which typically promotes short-term thinking, punishing companies that donâ€™t hit or exceed their quarterly targets, thatâ€™s worth noting. This week, too, Citigroup came out with a climate change policy, committing $50 billion in investment over the next decade. (More on that, I hope, in a few days.)
The Merrill report looks at greenhouse gas emissions in the UK, EU, U.S. and China. Using data collected by the four-year-old Carbon Disclosure Project, Merrill goes so far as to calculate a Rev/CO2 ratio for the companies on its â€œEurope 1â€ list of top ideas from ML European research analysts. Merrill found that
Many companies on the Europe 1 list are detailed and quantitative in their approach to environmental data reporting, which would support the thesis that a proactive environmental stance results in a higher quality business operations since these companies are ML analyst best ideas.
Again, none of this is earth-shattering. But it is evidence that we are moving closer to the day when investors will reward companies who lead the way on environmental issues, and penalize the laggards. That will be a very big deal.