Investors passionate about environmental, social, or governance concerns often use the ESG ratings to assess companies or equities worth investing in. The ESG rating tells investors the level of risk exposure a company has in these three areas. Therefore, issues such as energy efficiency and sustainability may have current and future financial implications that should be factored into investment decisions. A multitude of factors determine a stock’s ESG rating. By understanding how a company is rated, you can make confident investments that align with your long-term priorities. For more help managing your investments, consider working with a financial advisor.
What Is an ESG Rating?
An ESG rating evaluates the level of environmental, social, and governance risk exposure. Essentially, it tells investors how sustainable a company’s business operations are. Therefore, a high score would indicate to investors that the company either has values that they deem favorable or is proactive about guarding itself against environmental or governance risks such as pollution.
Investors may pause for concern with companies with lower ESGs because this might be less favorable for the investors’ portfolio and long-term financial goals.
Factors that Determine the ESG Ratings
When a company has a favorable ESG score, it means that the entity is doing well managing its environmental, social, and governance risk compared to other companies. On the other hand, a poor ESG score means that the entity isn’t doing so well and has unmanaged exposure to these risks.
When referencing the ESG rating, you usually hear the MSCI ESG referred to. The MSCI ESG ratings range from leaders (AAA,AA), average (A, BBB, BB) to laggard (B, CCC). Not only does MSCI rate companies but they also rate equity and fixed income securities, loans, mutual funds, ETFs and countries.
The MSCI ESG score is based on 10 categories which break down as follows:
How MSCI Score Companies and Securities
MSCI evaluates companies through a rigorous, multifaceted process that leaves them with a numerical score, ESG rating, and comparative assessment with others in their respective industry.
Each vital issue has a timetable and possible impact that the MSCI uses to determine its weight. Issues that will take five or more years to have a negligible impact get a slight weight, while issues that have meaningful impacts two years out are weighted highly.
Issue scores and weights get integrated, and MSCI gives the company a score between 0 and 10. Then the score is adjusts depending on the industry. Depending on performance, the company is designated as ‘Leader,’ ‘Average,’ or ‘Laggard.’
|ESG Ratings for Companies|
The appearance of overlap in the numerical score ranges is due to rounding error. The 0-to-10 scale is divided into seven equal parts, each corresponding to a letter rating.
Why Does the ESG Score Matter to Investors?
The ESG score is just one factor investors can use to determine which investments are best suitable for their portfolio. So, if you want to add this analysis to make a better-informed investor decision, here are some tips when incorporating the score:
Example of ESG Rating
Starbucks (NASDAQ: SBUX) has an average MSCI ESG rating of BBB. Factors such as interns of corporate governance, raw material sourcing, and nutritional opportunities make Starbucks an “ESG leader” in this category among peers in the restaurant industry. Regarding carbon emission, it scores in the average category.
But, when it comes to safety, quality, and supply chain management, it ranks as a “Laggard.” However, Starbucks ranks ahead of other big names such as McDonalds (BB), Burger King (BB), and KFC and Pizza Hut owner Yum! Brands (BB). On the other hand, Starbucks falls behind companies like Compass Group (A) and Ocado Group (A).
Consequently, if you want to invest in Starbucks, you may want to take a deep dive into their supply chain management concerns and how that could impact your returns in the future. Understanding these risks will help you assess if Starbucks is the right choice for your portfolio.
The Bottom Line
Highly ranking ESG stocks reflect sustainable, fiscally responsible business decisions that provide better results for the company and the investor. Company behaviors that decrease risk and increase return are always good news for investors looking to improve their portfolios. Therefore, adding ESG ratings to your investment assessment can help you make better investing decisions.
Tips for Investing
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