Extra-financial, sustainable and cost-effective analysis
#SRI — 17.02.2022

Extra-financial, sustainable and cost-effective analysis

Despite being essential to sustainability, extra-financial risks are still poorly managed due to a lack of data. And yet, they threaten 90% of the valuation of the world's largest stock index

Summary

  • Historically, a company's analysis was based on its earnings
  • Brand and reputation, etc. now account for 90% of the S&P 500’s market value
  • Extra-financial risks threaten the valuation of these “intangible assets”
  • These risks are based on Environmental, Social and Governance criteria
  • Data remain limited despite their impact on sustainability and profitability
  • The European Commission and labels allow investors to act      

Historically, the analysis of a publicly-traded company was based on tangible financial data such as sales/revenue , indebtedness, cash flow, expected earnings, business sensitivity to the economic climate, fixed assets (buildings, machinery, etc.), and so on. Today it is increasingly complemented by an analysis of extra-financial risks. This approach is based on Environmental, Social and Governance (ESG) criteria. A focus on the latter obviously reflects a shift in sustainability concerns. But the growing importance of extra-financial analysis is also linked to the changing corporate fabric.

« In 2020, 90% of the market value of the American S&P 500 index, a true global stock market barometer, accounted for intangible assets. »

Caroline Palumbo 
Investment Communication Manager

Intangible assets

Until the middle of the 20th century, our economies relied on the primary (agriculture, mining) and secondary (industry) sectors. The valuation of companies was based on their earnings and book assets.  Today, the tertiary sector is predominant. Moreover, intangible assets, which include the company’s brand, expertise, reputation and risk management, have become key. In 2020, 90% of the market value of the American S&P 500 index, a true global stock market barometer, accounted for these intangible assets, compared with 17% in 1975.

Since the Paris Climate Agreement in 2015, environmental risks have taken a prominent place in the valuation of these assets.

 

« These reports lack uniformity, and the materiality of the identified risks on profitability is rarely measured.»

Caroline Palumbo Investment Communication Manager

Incomplete ESG reporting

Since January 2017, EU law has required all publicly-traded companies with more than 500 employees to provide an ESG balance sheet. Environmental (E) risks include water and waste management, CO2 emissions, etc. The S focuses on the management of social and human capital with criteria such as gender equality, the respect for human rights, and staff retention. G refers to the corporate governance model: decision-making processes, the dialogue with shareholders, supply chain compliance. Although these reports provide much information, they lack uniformity, and the materiality of identified profitability risks is rarely measured.

Accelerating the transition

ESG analysts therefore need to juggle the valuations of several extra-financial rating agencies. Fortunately, the European Commission has understood the urgency of the situation. In 2022, it will have established a dictionary of economic activities based on their contribution to sustainability. This will standardise the ESG reporting of companies with a headcount of more than 500.

Sustainability labels, such as Febelfin's Towards Sustainability  in Belgium, provide binary albeit essential visibility.

Companies have understood the threat: insurance companies incorporate the risk of bad weather, oil producers are working on their reconversion to renewal energies... but investors can encourage them to accelerate their transition

The opinions expressed on this article are those of the authors and do not necessarily represent the position of BNP Paribas Wealth Management.

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