In my 25 years as a sellside analyst, I learnt that investors like to keep it simple. After a long discussion about the ins and outs of strategy, brands, operations and quality of management, the conversation with an investor would inevitably end with the questions “so what is the valuation?”
If you look on the front of an analyst note on a company, it will mention many different valuation metrics; from price targets, which are usually based on a discounted cash flow model, to dividend yield which reflects the dividend paid to investors. But I would argue that 90% of investment decisions are made by reference to one ratio, the infamous PE, or price earnings ratio. And it is very simple calculation, based on the company’s current share price divided by the earnings per share (EPS), which is the profit number at the bottom of the profit and loss account after taking account of interest payments and tax. Generally speaking, a high PE would reflect a market view that the EPS will grow fast; a low PE that it will grow more slowly than the average.
So you can imagine how baffled many fund managers appear when they are confronted by reams of sustainability data from companies, which set out measures, and often targets, based on a variety of different definitions, with often little communality. It is not easy for the corporates either, as they are often requested to complete detailed sustainability questionnaires from 200 different organisations and are then perplexed when the ESG ratings awarded by these organisations are all over the place.
I think, therefore, that we should applaud Danone, the French food company, which has a long history of embracing sustainability. It has made a “first step to provide visibility into the cost of carbon emissions to earnings”. With its full year results last week, the CEO said that he wanted to start a conversation on this subject and disclosed the movement on the company’s EPS numbers in the last 2 years after taking into account an estimated financial cost for the carbon emissions on its entire value chain.
It should be no surprise that this “carbon adjusted EPS” number is lower than the company’s normal EPS. You might have worried that the stock market would react negatively to this news as it would appear to put a higher valuation, or PE, on the company’s shares. In actual fact, the share price went up marginally on the day of the results, which would argue that investors were already mindful of the potential impact, even if they had not seen it quantified before.
What is for sure is that Danone’s move here will put more pressure on other companies to make similar types of disclosure which attempt to combine, in a simple ratio, traditional investor valuation tools with sustainability impacts. It will not be good enough in future for a company just to throw out a lot of statistics on sustainability subjects that “show the right result”; there will be pressure to disclose the total carbon footprint, which will allow more comparability between corporates, as well as linking this to valuation.
And investors, as well as other stakeholders, are likely to warm to companies which keep it simple.