Profit is no longer the only way to evaluate a business. Other metrics can be used when businesses’ social and environmental impacts are increasingly crucial to investors.
Other business evaluation methods allow investors to incorporate their values into their investing. Integrating values will enable investors to select companies that contribute to an ideal future.
One relatively new method focuses on environmental, social, and governance (ESG) criteria. Keep reading to learn the basics behind this new metric, how companies calculate it, and how you can evaluate your investments.
ESG scores
An ESG score is a number that rates a company’s performance on environmental, social, and governance issues on a scale of 0 to 100. The higher the score, the more efficiently the company performs on these issues.
Independent third parties create the rating, such as MSCI, Sustainalytics, or Bloomberg. These companies use different methodologies, but they all consider various factors in their ratings.
Factors that an ESG rating may consider include a company’s emissions, its treatment of employees, human rights records, corruption, and board diversity.
How do you calculate an ESG score?
The third-party evaluators use publicly available data to calculate ESG scores. The data is analyzed and weighted to create a score.
After creating scores for every company in a field, companies are put into a tiered rating system so investors can quickly compare companies. For example, MSCI rates companies on a scale of AAA to CCC.
You can use many different variables for an ESG score. The concerns for the environmental score include the following:
- Carbon emissions
- Carbon footprint
- Toxic emissions
- Use of environmental management systems
- Use of renewable energy
- Sourcing of water and raw materials
Standard variables used for social scores are:
- Labor management
- Working training
- Product inspection standards
- Health and safety protocols
- Worker and consumer safety
- Employee benefits
The governance considerations include business ethics, investing practices, and diversity leadership.
Many companies calculate ESG scores, and each company weighs the three pillars differently, so when you evaluate a company by its ESG score, you must use the same company’s metrics.
How can you use an ESG score to your benefit?
The primary benefit of ESG scores is that you can evaluate a company on metrics other than its business performance. It is a more holistic way of assessing a company.
This information can help you make investment decisions that align with your values. For example, if you want to put money into environmentally friendly companies, you would look for companies with high ESG scores.
You can also use an ESG score to compare companies within the same industry to know the industry leaders in social issues in that particular field.
Wrap up
ESG scores are a relatively new metric that rates a company’s environmental, social, and governance performance. The higher the score, the better the company performs on these issues.
You can use ESG scores to evaluate the social and environmental impact of companies you are interested in investing in and ensure that your investments align with your values.
