Does anyone remember ‘shareholder value’? It was all the rage about 15 years ago but has largely disappeared from the investor’s lexicon.
Personally, I think its disappearance is very welcome. It was an arrogant phrase, implying that the interests of shareholders were paramount and should be addressed immediately. The interests of other stakeholders were, by implication, of much lesser importance and could largely be ignored.
ESG (environmental, social and governance) is the buzz-phrase today and is soft and cuddly rather than arrogant. It implies a more thoughtful, holistic approach to corporate life and is notable for omitting any mention of profitability.
I suspect the ESG agenda will prove more durable than shareholder value, but it is still worth asking the question: do profits still matter in this new ESG world? Is there a conflict between making money and saving the planet in a socially inclusive way?
The stock market is often accused of being excessively short-term. The supporting evidence is usually that companies that grow near-term profits are rewarded by a rising share price. Not only does this observation raise the question of whether a falling share price would be somehow more appropriate, but it also ignores the huge differences in valuations in sectors with different long-term prospects.
Fuel for thought
The automotive industry is a fascinating case study of short-term versus ESG. Entirely for reasons of self-interest, the legacy car makers have generally been very slow to adopt electric vehicles. The first fully usable electric car, the Tesla S saloon, went on sale in 2012. Almost a decade later and the premium car makers are only now starting to roll out electric cars.
There was nothing revolutionary about the engineering of the Tesla, but the legacy makers continued to invest almost exclusively in petrol and diesel cars. Their reasoning was a blend of smugness, inertia and fear of cannibalisation: switching to electric cars would not create a new revenue stream and would demolish existing supply chains. It was an approach that left openings for new entrants, of which Tesla is only one.
Corporate history is littered with the bodies of companies that thought the best response to a disruptive new technology was to hope it would go away. The list of product categories that have been swept away includes mainframe computers, film cameras, incandescent lamps and now probably the internal combustion engine.
Groupthink is a powerful force, and breaking the mould requires an iconoclast who would almost certainly not have risen to the top in a conventional company
Share prices are volatile, but Tesla currently represents around a third of the world’s total market capitalisation for car companies, despite it making about 1% of the world’s cars. The legacy car makers, including some of the world’s most prestigious brands, trade on derisory valuations.
One can argue that Tesla is overvalued, but one can also argue that the stock market is taking a good look at the long-term prospects of the legacy makers and shuddering with horror. It now seems likely that petrol and diesel cars will be outlawed sometime in the next decade, creating an enormous problem, as millions of skilled jobs will be under threat.
Legacy car companies talk a good story about ESG and sustainability, but the reality is that almost all of them prioritised short-term success over long-term survival. There was no technical or financial reason why one of them could not have copied Tesla’s lead but all of them chose not to. Groupthink is a very powerful force, and breaking the mould requires an iconoclast who would almost certainly not have risen to the top in a conventional company.
There is also good cause to believe that companies will face rising pressure from investors to take ESG seriously. According to a recent Financial Times article, about US$3 trillion has been withdrawn from actively managed equity funds and invested in passive trackers over the past decade. If we assume that trackers charge about 100 basis points less than active funds, then fund managers have lost about US$30bn of gross income. A rare bright spot has been the recent surge of investment into active ESG funds. It seems very likely that active investors are going to have to take ESG seriously, as it is one of their few growth opportunities.
My primary point here is that the stock market will happily take a long-term view, and ignore short-term financials if it thinks the ultimate rewards will be worth it. Tesla is now profitable and the market is, in effect, assuming that a large share of future global automotive profits will accrue to Tesla.
My more subtle point is that there doesn’t have to be any conflict between purpose and profits. In my experience, the companies that prosper most over the longer term are the ones that put their customers first, not their shareholders. If you deliver something that customers really appreciate in a way that accords with their values, then success is likely if you execute well. As soon as you put your customers’ needs below other interests, though, you are potentially sowing the seeds of your own failure.
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