We manage an equity strategy that invests in companies we expect to benefit from efforts to tackle climate change, so we understand the concern.
We don’t hold Tesla in our portfolio. But we do own shares in other companies whose products and services help to avoid greenhouse gas emissions from transport, as well as from electricity generation, factories, offices, homes and other sources.
Like most investors, we hate paying too much for a stock. Fortunately, we think there are plenty of companies making the global economy more sustainable whose shares represent good value. But it’s increasingly important to invest selectively.
Capturing decarbonisation-fuelled growth
Conceptually, the case for investing in businesses whose products address the world’s carbon problem is straightforward. ‘Decarbonising’ the economy requires far-reaching changes to the way the world produces and consumes. That’s going to present enormous opportunities for some companies, and existential challenges for others.
For equity investors, the idea is that the winners from decarbonisation may be able to grow faster than other companies, so their shares have the potential to outperform. The faster the low-carbon transition occurs, the more we’d expect these stocks to outpace the market.
Last year saw a big acceleration of decarbonisation, despite (and in some ways because of) the pandemic. Among the major developments, China, Japan and South Korea committed to ‘net-zero’; the European Union put clean-tech at the heart of its COVID-recovery plan; and the UK adopted one of the world’s most ambitious carbon goals. Joe Biden’s US election win capped a remarkable year in global climate policy, bringing to the White House a president with a strong environmental agenda. Not surprisingly, this boosted the shares of companies seen as well-placed to benefit from the low-carbon transition.
Given governments’ determination to reduce emissions – coupled with consumer preferences for sustainable products, and the fact that green technologies are becoming better and cheaper – we think the rationale for investing in decarbonisation is stronger than ever. But are the shares of ‘carbon-avoiding’ companies now overpriced?
A common way to value a share is to compare its price to the profits a company makes. This is typically expressed as the price-earnings ratio. Last year, share prices rose by more than aggregate company profits, and so the price-earnings ratio of broad equity benchmarks like the MSCI All Countries World Index (ACWI) increased – i.e., shares generally became more expensive.
We think the rationale for investing in decarbonisation is stronger than ever
The companies we focus on (again, which don’t include Tesla, but all of which help avoid carbon emissions) were no different. Their average valuation also increased, but only in line with the MSCI ACWI’s valuation gain, although their share-prices went up by more than the index. In fact, the gap between the two valuations, which is usually fairly slim anyway, narrowed slightly.
Keen mathematicians will appreciate that, for the difference between the two price-earnings ratios to remain stable, the above-market price increases of the decarbonisation stocks must have been accompanied by correspondingly higher profits.
What does this tell us? First, it shows that investors are no more excited about some stocks with the potential to benefit from decarbonisation than they are about shares generally. We think this is because the market is yet to grasp the economic transformation required to get anywhere near ‘net-zero’. A few green-tech companies and sectors dominate the headlines, but the low-carbon revolution taking place throughout supply chains and across industries is still largely being overlooked.
Second, we think it confirms that a selective approach to investing in decarbonisation is more important than ever. Some low-carbon areas look expensive to us, including some hydrogen and residential-solar businesses. But parts of the electric-vehicle supply chain, for example, are still being priced in line with the traditional auto sector, rather than tomorrow’s clean-tech transport system (and nowhere close to Tesla’s approximately 170x earnings valuation).
Of course, whether Tesla, the MSCI ACWI or any other stock represents good value depends on how successful you think the respective companies will be in the future. Like beauty, value is in the eye of the beholder. But we might all agree that there are multiple ways for investors to align a portfolio with the low-carbon growth trend. And they needn’t come with a hefty price tag.
By Graeme Baker & Deirdre Cooper,
Co-Portfolio Managers, Ninety One Global Environment
Investment involves risks, losses may be made. No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided.
Nothing herein should be construed as an offer to enter into any contract, investment advice, a recommendation of any kind, a solicitation of clients, or an offer to invest in any particular product. Any decision to invest in strategies described herein should be made after reviewing the offering document and conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. This material does not purport to be a complete summary of all the risks associated with this Strategy. A description of risks associated with this Strategy can be found in the offering or other disclosure documents. Copies of such documents are available free of charge upon request.
Illustration by Adam Mallett