In this post, we will look at ESG metrics and their related pieces of information.
ESG metrics Uses
ESG metrics are used to assess a company’s vulnerability to a variety of environmental, social, and governance risks. These metrics can be applied to a variety of ESG integration strategies, including benchmarking and scenario analysis.
The use of ESG metrics in investment analysis is similar to traditional financial analysis; for example, when comparing a company’s revenue growth or margins to those of its peers. However, the key difference with ESG metrics is that they use non-financial data, such as the level of greenhouse gas emissions or the number of health and safety incidents in a year.
This means that ESG metrics can help us to understand a company’s exposure to ESG risk but, on their own, they don’t tell us the impact of this risk on a company’s future earnings and cash flows. Other ESG data is therefore often used alongside ESG metrics during investment analysis.
Key Learning Points
- ESG metrics are often used during ESG investment analysis, to assess a company’s exposure to ESG risk
- ESG metrics are non-financial metrics that help measure the various ESG risks faced by companies. ESG metrics are different from financial metrics, such as EPS or EBIT, as these are expressed in non-monetary units
- Environmental metrics measure environmental risks which include carbon emissions, energy efficiency, waste management and whether a company’s inputs and outputs are recycled
- Social metrics measure social and human capital risks which include a company’s supply chain, product safety, data security, labor practices, and employee health and safety
- Governance metrics measure governance risks which include business ethics, management remuneration, board/ownership structure and financial reporting transparency
ESG Metrics Explained
Environmental metrics help us to assess how much a company’s activities generate pollution & waste or use finite natural resources. Investment analysis often considers the trend in the metric (such as the % change in landfill waste from one year to another) as well as the ‘intensity’ of the metric relative to the company’s productivity (such as the amount of landfill waste per m$ of revenue). Intensity metrics are particularly useful when comparing a company to its peers.
Below shows common environmental risks faced by companies and the metrics used to measure these risks:
|Environmental Risks||Environmental Metrics|
|Carbon Emissions (“Greenhouse Gas” or “GHG” Emissions)||● Amount of GHG emissions (Mtons) ● Emissions intensity (Emissions per unit or m$ revenue)|
|Energy Efficiency||● Amount of energy used (mj) ● Energy intensity (Energy per unit or m$ revenue)|
|Waste||● Amount of waste generated (Mtons) ● Waste intensity (Waste per unit or m$ revenue)|
|Product life cycle||● % product from recycled materials ● % product recyclable or compostable (including packaging)|
The social risks faced by a company are linked to both social capital and human capital. Social metrics rely on event counts or the number of high-risk events that have occurred during the year.
|Social and Human Capital Risks||Social Metrics|
|Supply chain||● % revenues/suppliers covered by supplier codes of conduct or principles recognized within an industry|
|Product safety||● Fines/litigation related to product safety ● Number of product recalls|
|Data security||● Number of data breaches per annum ● Fines related to data security|
|Labor practices||● Employee turnover ● Fines/litigation related to employee matters|
|Employee health and safety||● Lost time (employee hours lost to health and safety) incident rates (LTI per 100 employees) ● Fatality rates per annum|
The following are commonly used metrics to measure the key governance risks faced by businesses:
|Governance Risks||Governance Metrics|
|Business ethics||● % revenues in countries with high corruption risk ● Fines/litigation related to business ethics|
|Management remuneration||● Total amount of executive pay/EBIT ● % executive pay performance-based (salary versus bonus)|
|Board/ownership structure||● Age/gender/expertise diversity on board ● % equity owned by the board (high levels of management ownership may increase governance quality)|
|Accounting/disclosure transparency||● Earnings quality (e.g., the number of exceptional items) ● Absence of key disclosures|
A key limitation for governance metrics is that the underlying information can be very qualitative in nature. For example, analysts may want to assess the quality of management policies and procedures in place for managing corruption risk. To overcome this qualitative issue, analysts often assign a ‘quality score’ to the company’s policies and procedures, allowing them to compare the company to its peers.