| sdEffect 101 |
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| 05/08/2007 | |
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Ron Yachnin, Principal at Yachnin & Associates, answers this week's questions on valuing sustainability. What is the sdEffect? It is an approach that translates corporate sustainable development (SD) performance data into financial valuation measures to help isolate effects on share price appreciation and company valuations. It applies standard financial valuation techniques such as Ratio Analysis, Discounted Cash Flow (DCF), Rules of Thumb Valuation, Economic Value AddedTM (EVA) and Option Pricing to SD metrics such as energy use and community involvement, to demonstrate how business aspects traditionally viewed as "soft" by analysts can be translated into hard valuations. What advantages can it offer to institutional investors? It is an important contribution in that it surmounts a big obstacle that has been standing in the way of the integration of sustainability in investment decision-making – that of going beyond anecdotal evidence of the business case to translating operational data into usable financial information. It enables companies, institutional investors, analysts and others to show direct causal links between SD and financial factors; understand the valuation implications of SD practices and enhance communication regarding relative value premiums associated with core valuation drivers effected by SD factors; make better strategic decisions regarding SD invest-ments and trade-offs which can lead to greater uptake of SD practices; communicate the additive value of SD practices and how they can be factored into company risk profiles and valuations; capture the longer-term SD valuation effects that can accrue from SD and thereby facilitate development of a longer-term investment mindset; and, heighten the capacity of capital markets and economies to capture this additive value and thereby strengthen the ability to innovate, compete and create wealth. It is only when sustainability performance is understood in terms of financial performance that it can be effectively measured, managed, reported on and invested in – and become more central to strategic decision making. This analytical approach is innovative in terms of bringing corporate sustainability performance information together with financial valuation techniques to provide financial valuation results. As such, it offers an important bridge between sustainability and finance using data and techniques that are readily available. Finally, it provides specific examples of how sustainability can influence the domains of magnitude of cash flows, timing of cash flows, and risk to cash flows. What are its constraints and limitations? The approach is dependent on corporate sustainability performance data that is suitable for translation. One limitation is that reports are often characterized by an absence of specific and quantitative information that limits valuation of much of a company's reported SD practices. Also, relevant SD data is often scattered and thereby difficult to assemble and analyse for the purposes of ascertaining general additive value and translation into valuation. The approach can sometimes require that a company, investor or other make estimates as to elements of the model such as how a particular action may influence cash flows. This is more an issue of the requirement for those applying the tool to build in their own assumptions and estimates. |
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Articles of the same Serie : 101 |
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