Road to ESG integration: embedding ESG into target prices
Earlier this year, we published the first in a series of “Road to ESG integration” reports, defining and quantifying at sector level the key financially relevant themes that would have a direct bearing on our qualitative approach. We received a great deal of positive feedback for this exercise, but one question was asked time and time again: “How do ESG signals affect valuations and target prices at the stock level?”
In this report, our analysts quantify the importance of Environment, Social and Governance (ESG) factors and embed the result into the valuations of the majority (411) of the stocks we cover (489). Unlike the traditional top-down quant ESG approach to valuation, the bottom-up approach we use differs from sector to sector and from company to company. This is because we have given each analyst a free hand to determine the ESG impact on their own individual stock valuations.
This report, pioneer of its kind, represents a major shift in our equity research towards the systematic integration of ESG concerns into the valuation models of our covered companies. It is a first insight into a more responsible way of looking at industry and companies.
Main takeaways (from theory… to practice):
The case for integrating ESG considerations into formal target prices has never been stronger.
It is naive to assume ESG considerations are ignored by mainstream research as forecasts must also embed a view on the impact of ESG factors on external stakeholders, as well as on the sustainability of terminal value assumptions.
We believe that formal valuations/target prices are an integral part of the investment process.
There is an overwhelmingly large amount of quantitative ESG data available, often prohibitively complex and accompanied by a disconcerting dispersion in ratings.
Sector analysts unanimously agree that the systematic review of ESG concerns has proven worthwhile as an effective due-diligence tool.
Analysts have proven to be highly discriminating in that they typically focus on just one or two valuation-relevant issues at a time.
Analysts have been more prone to focusing on ‘E' & ‘G' than on ‘S' issues.
In this report, c.16% of target prices were changed by analysts applying an ESG-specific premium/discount (12% of TPs upgraded, 4% downgraded).
There is no clear correlation between a negative ESG-specific valuation impact and SG's stock recommendations, as analysts often see the issues as addressable (‘there is significant upside potential if the issue is corrected' was a common view). This is consistent with SG's view that in a genuinely integrated approach, what matters is the ESG-adjusted risk-reward balance.
Companies show similarities to living organisms, with ESG considerations constantly emerging or subsiding. We intend to periodically review the ESG profiles of the companies we cover and adjust our ESG impact assessments accordingly.
About Societe Generale Cross-Asset Research
Societe Generale Cross-Asset Research is composed of more than 200 Analysts, Strategists, Economists and Quant, combining their expertise into ‘Research-based’ and innovative solutions suited to client’ needs: fundamental studies and expert views, investment ideas and long-term strategies, trade ideas and tactical baskets, thematic and systematic indices, quant solutions. On top of its established UK and Western European base, Societe Generale Cross-Asset Research benefits from a global coverage thanks to its presence in the US and in Asia (Hong Kong, Singapore, Tokyo and Bangalore) and Societe Generale local networks in Eastern Europe.
This editorial contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of Societe Generale. This interview is dedicated to institutional and professional investors and is not deemed to be seen and used by retail investors for investment purpose. The viewers shall consult their own financial advisers to make their own appraisal.