#24 ESG Can 2x Your Company's Value

Research by Deloitte has revealed a surprising link between ESG performance and company valuation.

3 min read

A company that excels at ESG is able to balance the interests of all stakeholders - not just its shareholders.

But doing this has a beneficial effect on its investors too: the market responds by placing a higher value on a company with strong ESG performance.

This should not come as a surprise - if a company is keeping all of its stakeholders happy, it is likely to be successful and continue to be successful in the future.

For this reason, ESG score is a proxy for resilience and future performance.

Measuring ESG Performance

Several organisations have developed methodologies to score a company's ESG performance.

Deloitte's research used Refinitiv (now LSEG), which captures and calculates over 500 KPIs to generate a score on a scale of 0-100.

Deloitte then analysed hundreds of publicly listed companies across multiple industries and began by exploring the correlation between ESG score and EV (enterprise value) multiples.

The Importance of EV Multiples

EV multiples are calculated by dividing a company's valuation by its profit.

For a listed company, it's valuation is the combined value of its shares at any point in time (called market capitalisation).

When the financial markets have high expectations for the company's future financial performance, it's share price will increase relative to its profits, resulting in a higher EV multiple.

In simple terms, a bigger multiple indicates better long-term financial prospects.

EV multiples are also very important for private companies, especially those planning for an exit.

The valuation a prospective buyer will place on the business will be a multiple of the company's profits (usually EBITDA).

The multiple is influenced by many factors - which we'll come back to.

But the surprising finding from Deloitte's research is that ESG performance has become one of the most significant factors.

ESG Score & EV Multiples

Deloitte started with a simple correlation between ESG performance and EV multiples, splitting the companies into four groups according to ESG score.

It found a significant correlation as shown in the chart below:

While this shows a strong link, there may be other factors at play that also influence the EV multiples of these companies.

Deloitte undertook a regression analysis to isolate the impact of ESG performance, and to also look at the effect of a 10-point improvement in ESG score - which was found to increase EV multiples by 1.8x.

Improving your ESG score can therefore have a significant impact on the value of your company.

We'll use some simple numbers to illustrate this.

Worked Example

Let's say a company is generating £5m EBITDA and has a satisfactory ESG score of 50.

Its shareholders are considering an exit in the next 12-18 months and the corporate finance advisors they've spoken to believe that an 8.0x multiple is achievable.

The company commits to improving its ESG score, targeting a 30-point increase, and with the benefit of the Towards Better methodology is able to link ESG to financial performance and boost its bottom line by 20% at the same time.

The 30-point increase equates to a 5.4x uplift in EV multiple (3 x 1.8) and this results in its valuation doubling to £80m.

Using it to Your Advantage

Most of the factors that influence EV multiples are beyond your control: industry growth rates and competitive landscape, regulatory environment, general macroeconomic conditions etc.

There are some important 'internal' factors, such as the strength of IP and profit-to-cash conversion - but it takes a long time to change these.

ESG performance is entirely within your control, and can be sufficiently improved within a sensible timeline for exit planning.

Next week we'll take a further look at why strong ESG commands a premium, and the practical steps you can take to maximise it.

The journey towards a better way of doing business

We are on the cusp of a new paradigm of responsible business, and helping impactful companies pair purpose with profit will accelerate the shift.

I believe this holds the key to solving many of our greatest challenges and inspiring positive change throughout society.

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