There is a growing awareness that stock returns are influenced by Environmental, Social and Governance (ESG) considerations. As a long-term proponent of incorporating ESG factors into our assessment of companies, Harbour is delighted to have been involved in Armillary Private Capital’s annual review of returns of the NZ listed sector for 2018 that was released last week.
This is Armillary Capital’s ninth annual Return on Capital Employed (ROCE) report. ROCE is a measure of efficiency, calculated by comparing a company’s net operating profit to its capital employed. Their research looks at the overall market ROCE, top performing stocks for 2018, and a look at some of the differences between sectors of the economy. Key highlights of the report include:
- A comparison of Return on Capital Employed (ROCE) and ESG factors display a positive relationship
- The median 2018 ROCE performance across all listed and Crown Entities surveyed dropped to 6.98% in 2018, from 7.61% in 2017, which is below common estimates for the market average weighted average cost of capital (WACC) of 8%.
- Lower ROCE for New Zealand companies may be explained by the sector composition of our market, especially given more exposure to regulated utilities here
- The best performer in the 2018 survey was the a2 Milk Company with ROCE of 166.8%.
Click here to view the full report.
Return on Capital Employed breaks down the performance of a company by its profitability and activity which are represented by financial metrics. Conversely, ESG factors are traditionally considered as non-financial metrics which may represent underlying risk or opportunities that materialise in company performance over the long term. They include measures such as carbon footprint, human capital management, governance, ethics, diversity, stakeholder relations and board composition which can be subjective and more difficult to quantify.
We conducted our own analysis comparing ROCE with Harbour’s Corporate Behaviour Survey ESG scores from the NZX50 over the past few years. The results from our statistical analysis revealed a moderate, positive relationship between a high ROCE and a high ranking ESG score. This reinforces the idea that company performance can be explained by multiple factors, both financial and non-financial.
Harbour has long assessed companies’ management of ESG risks and opportunities, and our scores have shown efficacy when compared to stock returns over the long term as can be seen in the following chart.
Source: Harbour. Company names have been hidden for confidentiality reasons.
To find out more information about Harbour’s ESG approach, please click here to view our ESG policy.
As the evidence and awareness grows of the linkage between companies’ management of both financial and non-financial risks and their performance over time, ESG is increasingly a “must have” rather than a “nice to have” feature of in-depth investment research.
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