February 14, 2006
Financial Wonks Meet Treehuggers: New Tool Places Valuation on Corporate Sustainability
by Bill Baue
The sdEffect analytical framework takes the next step in establishing metrics to translate
sustainable development into valuation.
Financial geeks and environmental and social activists alike will love the middle section of the report accompanying the
launch of sdEffect, a new Pilot Analytical
Framework that translates corporate sustainable development (SD) practices into financial
valuation. This section includes lots of numbers and percentages and acronyms for financial
analysis techniques, including ratio analysis (such as price to earnings, or P/E), discounted cash
flow (DCF), rules of thumb valuation, economic value added (EVA), and option pricing. It also
includes terms rarely if ever seen on financial analysts' spreadsheets, such as greenhouse gas
(GHG) emission reductions, diversion of non-hazardous waste from landfills, respect for Aboriginal
peoples/First Nations, and awards for environmental reporting.
responsible investing (SRI) and corporate social responsibility (CSR) have long been integrating SD
considerations philosophically and in practice, the sdEffect marks the inaugural effort to "show
direct causal links between SD and financial factors."
"In the world of financial
analytics, there is no better measure than impact to the bottom line," writes Don Reed, president
and CEO of Franklin Templeton
Investments in the report's Foreword. "The challenge is how to translate the concept of
sustainable development to the bottom line performance of a company."
"The report provides
the first steps in using financial language to measure the impact of sustainable development on the
bottom line," he adds.
Ron Yachnin, principal of Yachnin & Associates and one of
report's authors, confirms the seminal nature of the framework.
"As far as we know, this
is entirely new," Mr. Yachnin told SocialFunds.com, though he acknowledges that firms such as
Goldman Sachs (GS), Citigroup (C), Merrill Lynch (MER), and Generation Investment Management have been
integrating SD factors into their financial analysis. "It's hard to know what financial analysts
at Goldman Sachs are doing behind closed doors, but we suspect they are not doing this."
The sdEffect framework makes public its analytical techniques, so that mainstream financial
analysts can finally quantify the financial implications of issues they previously ignored because
they considered them "soft" or did not understand how to valuate them.
audiences often are unfamiliar with the environmental and social language of SD, but they are
extremely adept at assimilating information when it is expressed in terms of revenue growth or free
cash flow (magnitude of cash flows, timing of cash flows, risk of cash flows)," states Mr. Yachnin
and co-authors in the report.
The report focuses on five Canadian mining companies--Alcan
(ticker: AL), INCO
Dome (PDG), and
Teck Cominco (TEK-MVA.TO)--in part to limit scope
to one sector, and in part because all five have produced recent sustainability reports. The
report notes the challenges of extracting sufficient data even from these reports.
a surprise finding that the data in the sustainability reports isn't predisposed to dealing with
quantitative analysis," said Mr. Yachnin, who estimates that only about 10 percent of the
information in sustainability reports can be translated into financial valuation. "What we found
in looking at these sustainability reports is that they are very descriptive about what companies
are doing, but when it comes to providing information about how sustainable development initiatives
add value to their businesses, they stop short."
Despite the small amount of
quantitative data, sdEffect methodology still yielded seemingly significant results. For example,
the report uses discounted cash flow as well as price-to-cash-flow-per-share (P/CFPS) valuations to
determine that Falconbridge's GHG emissions reductions (six percent energy consumption reduction
per unit of output) results in increases per share value of $1.62 to $2.44.
framework "pilot" acknowledges the early stages of development, and the report maps out next steps
"To facilitate the identification of additive value and translation
into financial valuation, it is therefore recommended that companies report key SD metrics and
related valuation information in a single summary table; preferably appearing early in related
reports and communications," states the report. "Two main types of additional investigation are
required to advance this field over the immediate term [including] 1) conducting comparable
analyses for other sectors and additional metrics, and 2) working with companies to apply the
"We have already had a number of expressions of interest to join the
initiative including from an multilateral organization, a major mining company and a Canadian based
bank," said Mr. Yachnin.