How To Analyze a Sustainability Report?
Lack of standardization on non-financial reporting can make it difficult for investors to analyze what a given company is doing for sustainability. We came up with the most important aspect to look at while analyzing a sustainability report.
The main aim of for-profit organizations is to maximize shareholder value. It has been mandatory for companies to report on their financial performance, a financial situation as well as cash flow to help different investors make well-informed financial decisions. With the increasing pressure for companies to focus on Corporate Social Responsibility, many firms disclose their non-financial information to provide additional data for different stakeholders. Such non-financial information can include environmental, ethical, social, and anti-corruption aspects (ESG information).
According to the triple bottom line accounting framework, companies can evaluate their performance based on three different dimensions such as environmental stewardship, social responsibility, and financial performance. The idea of creating additional value for the company throughout those three dimensions has been first coined by John Elkington, author of books such as “Cannibals with Forks: The Triple Bottom Line of 21st Century Business” and one of the founders of the sustainability movement [1].
But as the pressure for non-financial reporting increased there weren’t many rules forcing companies to report on their ESG impact globally until 2014. As of 22nd of October 2014, an EU directive came to force mandating companies to disclose non-financial and diversity information by certain large undertakings and groups. The directive is valid from 2018 onwards and applies to companies with more than 500 employees within the EU. Nonetheless, one issue remains unknown.
What should be disclosed in such reports and how can the non-financial performance of companies be compared?
For conscious investors, a lack of precise KPIs included in the sustainability reports could make it difficult to compare and analyze non-financial information.
So what are the most important aspects of sustainability reporting?
UN Sustainable Development Goals (SDGs)
In their non-financial reports, many companies focus on their SDG compliance and divide their reports into what they are doing to meet specific SDGs. This can be useful information when considering different ESG goals we want the company to focus on. However, it is still important to make sure that a given firm encloses concrete data to back up their selected SDG focus as well as the progress they have made towards reaching that goal.
Greenwashing
Since there are more than 230 corporate sustainability standards initiatives across more than 80 sectors, companies can often manipulate the results and only disclose statistics that are favorable for the firm. Many companies have been found to “greenwash” their sustainability reports or performance, meaning that they report on focused goals or standalone statistics to appear more sustainable than they are, mainly for marketing purposes. It is important to remain critical of sustainability reports, to understand their real impact.
CO2 emissions
Companies that report on scope 1, 2, and 3 emissions [2] are exceptional, but this is a standard we would like to see. Scope 3 emissions are becoming of increasing importance with time and usually, they are the greatest share of the company’s CO2 emissions. This scope includes indirect emissions in the company supply chain such as business travel or waste disposal, except for electricity purchased emissions. If firms show performance and targets for scope 3 emissions specifically, then this is always a great positive value-added for their report.
Setting Targets but what next?
Targets and plans are valuable for an investor analyzing a sustainability report, but we prefer to see a strong plan of how companies will reach this target, so it is both achievable and believable, reporting on their past progress and why they are making these targets.
Progress is the key
The most comprehensive sustainability reports inform about progress (which can also be negative if a company’s growth leads to higher resources used). This means that firms show traceable statistics from the past, current, and future. An example of such a statistic could be water consumption or CO2 emissions.
If you want to see a role-model non-financial report, we would strongly encourage you to review the report published by the National Grid for 2019/20: “Our Contribution”.
Lack of standardization in sustainability reporting remains an issue that has been addressed more and more often. In late October, BlackRock the world’s biggest global investment management corporation issued a paper where it calls for companies “to achieve a globally recognized and adopted approach to comprehensive reporting.” [3]. With increased pressure on uniformed non-financial reporting standards, we hope that soon sustainability reporting will become a new norm.
[1] Triple bottom line https://en.wikipedia.org/wiki/Triple_bottom_line
[2] What is the difference between scope 1,2 and 3 emissions? https://compareyourfootprint.com/difference-scope-1-2-3-emissions/
[3] Sustainability reporting: Convergence to Accelerate Progress. https://www.blackrock.com/corporate/literature/publication/blk-commentary-sustainability-reporting-convergence.pdf
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Thanks to Maarten van den Heuvel! (@mvdheuvel on Unsplash.com)