Successful long-term investing depends upon the identification of sustainable companies. We believe traditional investment analysis tends to underestimate some risks faced by companies today. In particular, we see rising risks to sustainability from the potential breakdown of relationships between industries and companies with society. Each company and industry operates under a "societal license” that, if damaged or revoked, can ultimately impact the bottom line. This relationship risk is rising in today’s market and social environment due to several interrelated factors, including evolving consumer values, environmental issues, social media, technological disruption, and lack of reinvestment (see Exhibit).
Relationship Risks are Rising Today Due to Several Interrelated Factors
Relationship Risk
Finding sustainable companies is an exercise in long-term risk analysis. Companies can fail for many reasons, including poor strategic decisions, excessive leverage, sloppy management, or a dramatic change in the competitive landscape. Today’s political, technological, and financial environments contain new risks to sustainability. These challenges not only threaten the long-term status quo, requiring appropriate management response, but they also accelerate the impact of any risk that starts to materialize.
In traditional risk analysis investment professionals compare companies to their peers and assess the health and prospects of their industry. We believe that both industries and companies rely on a societal license to operate. This societal license while ever present is invisible. It becomes obvious by its absence when customers abandon brands, regulators punish bad practices, or governments introduce laws to cap (and trade) emissions. We believe that the breakdown of these relationships— and the loss of this license—is the primary way sustainability risks may undermine company fundamentals and stock prices in the future. Our view reflects the growing importance of each company’s stakeholder relationships, which encompass customers, employees, governments, shareholders, and the environment.
A full analysis of all of a company’s relationships can result in a much broader and complete picture of investment risk. Consistently using a framework to evaluate these risks can help investors identify the most serious threats, uncover commonalities, build analytical skill, and avoid poor-performing companies.
The preceding is an excerpt from A Sustainability Framework: Societal Shifts as Investment Risks.
Read the full paper to learn more about the team’s sustainability framework.
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