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Morgan Stanley unveils framework for embedding sustainability into company valuations

Investment bank’s S+R team issues 116-page “blue paper” on ESG integration

Investment bank Morgan Stanley has released a comprehensive global framework for analyzing environmental, social and governance (ESG) risks and opportunities and embedding sustainability factors into valuing companies.

The blockbuster 116-page report is called ‘Embedding Sustainability into Valuation’ and has been put together by the bank’s Sustainable + Responsible investment research team headed by Jessica Alsford.

“This report provides a framework for each sector covered by Morgan Stanley’s equity research analysts in order to help investors incorporate environmental, social and governance risks and opportunities into their stock analysis,” the team writes in an executive summary. “We focus on materiality, and illustrate for each sector how each individual ESG factor can affect the various value drivers.”

The report – part of the bank’s ‘Blue Paper’ series addressing long-term structural issues – claims the reporting of ESG data is “often insufficient” for investors to make ESG-related investment decisions, so it provides a list of questions for each sector “to help investors engage further with companies on material ESG topics”.

The document analyses 29 global sectors and outlines the key inputs the bank’s equity analysts typically use to value stocks. It then overlays an ESG framework, focusing on material factors specific to each sector: “This enables us to show how topics such as carbon, supply chain and product safety can drive different parts of a valuation model.”

“Traditional investment analysis requires an assessment of company accounts, industry dynamics and the politico-economic outlook,” the team says.“However, we believe that environmental, social and governance factors should also be incorporated into equity analysis. This should not be done at the expense of financial returns; indeed, we think that, by better understanding the environmental, social and governance (ESG) risks and opportunities that a company faces, investors can improve their investment processes and decisions.”

“We believe that environmental, social and governance factors should be incorporated into equity analysis.”

The framework goes on to say that valuations are typically based on an analysis of how financial capital is deployed but “we supplement this with analysis of three other types of capital: natural, human and social”. Governance is also key to help ensure that capital is deployed in the best way to enhance shareholder returns.

In separate research (‘Sustainability Themes – Top Picks Globally’) this month, the S+R team identified its top 30 global companies that it expects to outperform over the next 12 months on sustainability themes, filtered out from a long-list of almost 300 stocks to identify global stocks that offer exposure to at least one of its seven sustainability themes and “an attractive risk-reward on a 12- month time horizon”. The seven themes it has identified are: 1) Climate Change 2) Water Scarcity 3) Waste Management 4) Food Availability 5) Health & Wellness 6) Improving Lives 7) Ageing Population.

The companies are analysed in detail in a 47-page research note, broken down into the top 10 picks for the US, Europe and the Rest of the World.