Technology companies with higher ESG credentials, on average, receive higher valuations from the market, according to the latest research from Janus Henderson Investors.
As such, ESG should be a key consideration for investors when assessing valuations.
In a whitepaper titled: “What is the relationship between ESG factors & valuation?” the extent to which technology companies with robust ESG ratings receive a valuation premium was assessed with respect to three key valuation factors: price to earnings metrics, enterprise value vs. sales metrics, and enterprise value vs. EBITDA (earnings before interest, taxes, depreciations and amortization).
The paper was produced by the UK-based Janus Henderson Global Technology Leaders Team: Alison Porter, Richard Clode and Graeme Clark, who between them co-manage the Global Technology Leaders and Sustainable Future Technologies strategies.
The research covered over 700 equity securities over a three-year timeframe of 2018 to 2020.
To conduct the research, Janus Henderson divided the investible universe in to 20 groups of similar companies based on market cap, year on year sales growth, and quality (considering factors such as operating margin, net debt to EBITDA, and free cashflow per share).
The technology sector was also analysed by geography using the same three multiples.
ESG premiums widen across all markets between 2018 and 2020
Janus Henderson took the entire investible universe and split these companies by high and low scoring ESG factors across markets. A clear trend is seen from 2018 to 2020 as premiums widened, and all continents saw a premium given in 2020.
In Asia, in 2020 the higher scoring ESG companies received an on average premium of +36% versus the lower scoring companies.
Both Europe & North America, and indeed South America, saw sustained increases across the three years of data in the premiums given to higher scoring ESG companies with respect to the P/E ratio.
The analysis showed that the premium awarded for higher ESG ratings is not necessarily dependent on growth.
A popular misconception is that for high growth stocks on high multiples, ESG ratings would be less relevant. We show here that for high growth companies, the relationship is even stronger.
“ESG factors must be an integrated part of the investment process”
Alison Porter, portfolio manager on the Janus Henderson Global Technology Leaders Strategy, said: “The technology sector has been the single largest source of economic value creation and disruption in stock markets over the last decade.
By taking a deeper dive into this sector, we have sought to isolate factors that impact stock price performance and valuation and as such, attempt to remove the impact of technology disruption itself in order to examine the impact of ESG factors at a more granular level.
“Our team’s analysis shows empirically that companies which perform well on ESG metrics, and which can show significant improvement in these factors, will be valued more highly by investors in the markets and, crucially, that ESG factors must be an integrated part of the investment process.
“In our view, effective active engagement to improve environmental, social and governance aspects of performance is likely to have a positive impact on capital returns, however owning companies that are laggards on ESG metrics is appropriate only with a measured action plan.
“It is important to remember that ESG analysis is a relatively new discipline and investors must be aware of important nuances or gaps in the data. This is particularly the case when assessing the ESG credentials of smaller companies.”
