In fact, those at the U.S. Environmental Protection Agencys
Energy Star® program are so convinced that energy management
can play a role in determining stock performance, they have introduced
new metrics designed to help potential investors judge how a company
manages energy. While it will take time to prove the effectiveness
of these new metrics, money managers that practice green investing
or socially responsible investing are likely to embrace and test
them, because the metrics can provide another valuable tool for
predicting company performance.
One of the shortcomings of traditional financial analysis is that
it does not adequately measure intangible factors, such as corporate
responsibility and the quality of managementeven though these
factors can have a profound impact on stock prices. Having a means
to measure these factors could prove invaluable.
So is there a relationship between energy management, which is measurable,
and the overall quality of management? Energy Star thinks there
is. In fact, evidence is mounting that says managers who care about
energy conservation and the environment also care about their shareholders.
Likewise, companies that use energy efficiently are likely to operate
efficiently in other areas as well. More importantly over the long
run, companies that use energy efficiently are reducing investor
risk stemming from global climate change.
New studies by Innovest Strategic Value Advisors, a financial research
firm, support these conclusions:
* Innovest studied 12 companies in the commercial real estate sector
and found that, during the past two years, stocks of companies with
above-average energy efficiency outperformed stocks of companies
with below-average energy efficiency by 34 percentage points.
Note that the spread is not 34 percent, but 34 percentage points.
The six most energy efficient companies finished the two-year period
ending in June 2002 with a return of just over 30 percent, while
the six least energy efficient companies finished with a return
of minus four percent. Anyone investing in the below-average companies
would have a loss of four cents for every dollar invested in the
six companies for the past two years, while anyone investing in
the top six companies would have a two-year gain of 30 cents for
every dollar. (See chart 1, page 40.)
* In a separate study of 12 retail foods companies, Innovest found
that companies with above-average energy efficiency outperformed
below-average companies by 17 percentage points over the past three
Innovest does not claim that energy management is solely responsible
for the superior performance of the companies it studied, but that
energy management has a proxy value for management quality.
Effective environmental management is one of the most complex
challenges facing management, according to the Innovest report.
It is implied that companies dealing well with this high level
of complexity have the sophistication to succeed in other parts
of the business and thereby earn superior returns.
Although the number of companies included in the studies is small,
they represent a majority of each industry on a market-cap basis.
In addition, Innovest has studied the broader environmental performance
of stocks in more than 50 different sectors and has concluded that
stocks of companies with above-average environmental performance
outperform those of companies with below-average environmental performance
by three to 30 percentage points a year.
Likewise, Energy Star has found that public companies that have
joined the Energy Star program have thus far outperformed companies
that are not participating by more than six percentage points a
year. No wonder green portfolio managers are beginning to look for
the Energy Star label when they consider new investments.
Why Energy Matters
The link between performance and energy efficiency is likely to
become even more pronounced with the recent surge in energy prices
caused by war in the Middle East and the political turmoil in Venezuela
and Nigeria. This link is probably clearest in the commercial real
estate industry, where energy is the single largest operating cost,
accounting for a third of all operating expenses, according to Environmental
Quality Management. Energy Star reported that the best performing
buildings use only about a fourth as much energy as poorly performing
As a result, energy upgrades in commercial buildings typically have
a 20 to 30 percent rate of return and require little risk. Based
on a 10 percent capitalization rate, a building owner can generate
two or three dollars in incremental asset value for each dollar
invested in energy conservation.
A 30 percent reduction in energy costs can increase net operating
income by five percent, according to Innovest. Using the income
approach to appraisal, a five percent increase in net operating
income would result in a five percent increase in the asset value
of the building. If the building is in the portfolio of a real estate
investment trust (REIT), the higher asset value would support a
higher share price. Likewise, if the building is owned by a public
company, it can have a positive impact on the value of company shares,
and signal to analysts and money managers that the company is well
managed and is operating efficiently.
Energy Star has plenty of anecdotal evidence to support these conclusions.
One real estate company involved in the Innovest study compared
operating costs in buildings that meet Energy Star criteria with
those that do not and found that operating costs were 5.17 percent
lower in buildings that met the requirements, which translated to
a savings of $13 million a year. Energy costs alone decreased by
Likewise, a grocery store chain calculated that its energy program
generated enough savings to improve earnings per share for its parent
company by 10 cents in 2002. The chain created a Team Energy
task force that targeted its 250 least energy efficient stores.
Once energy management was improved at those stores, the task force
shared what it had learned with others throughout the company, so
that energy costs could be managed better at all 1,222 stores in
the chain. (See chart 2, page 41.)
Companies can improve their performance when they reduce energy
costs, because by reducing operating expenses, they free up cash
that can be put to other, more productive uses, boosting profit
margins. Energy conservation can also improve the companys
public image, create a competitive advantage, improve employee morale
and perhaps even create new business opportunities. In addition,
when companies reduce their energy use, they also reduce their greenhouse-gas
emissions, which reduces their exposure to liability from climate
change, which is expected to become a major issue over the next
These benefits can act as a catalyst to encourage businesses to
undertake energy efficiency programs, but only if the new metrics
are adopted and supported by the financial community.
Energy Stars Metrics
While the metrics being introduced by Energy Star will be useful
to investors, they will also help managers of companies within each
of the 26 different industries for which metrics have been developed.
Businesses dont invest significant amounts of capital into
new projects unless they can reasonably determine the potential
return on their investment. Energy Stars metrics will help
managers measure energy costs relative to other variables, and to
compare the results with the collective average of similar companies
within their industry. Commercial real estate companies, for example,
will be able to compare their energy costs in relation to sales,
cash flow, net operating income, operating expenses and assets to
see how they measure up with other companies in their industry.
To use Energy Stars Energy Exposure Index (EEI) to calculate
energy expenditures as a percentage of cash flow, for example, the
equation EEI = (EX/TCF) can be used, where the energy efficiency
index equals energy costs divided by total cash flow.
By itself, the percentage of cash flow that goes to pay energy costs
is useless, but Energy Star will provide an opportunity for businesses
to compare their performance with that of other businesses not only
in their own industry, but with similar operating conditions. A
commercial real estate manager, for example, will be able to use
a whole-building performance rating, comparing each building with
results from other buildings that are similar in size and construction,
that are located in a similar region, and that are being used for
a similar business activity.
Energy costs for a building in Boston, MA, obviously will differ
from the costs of a building in San Diego, CA. By taking these differences
into account, a company will be better able to determine where it
stands, relative to other companies in the same industry and with
the same operating conditions.
A Positive Program
The new metrics are an extension of an already successful program.
Energy Star already represents more than 5,700 organizations that
have committed to invest in energy efficiency. The Energy Star label
is ubiquitous on appliances and electronic equipment. Now, in addition
to introducing its new metrics, Energy Star is forming affinity
relationships with investment firms that are willing to use its
metrics as a non-exclusive screen.
Clearly, Energy Star is working because it works with businesses
to help them reduce costs. It demonstrates that being green can
be good for the environment and the bottom line. Environmental regulators
are often criticized by businesses for imposing costly restrictions
that make it more difficult for them to compete, but Energy Stars
new metrics demonstrate that environmental responsibility can benefit
businesses and the environment at the same time.
Jackson W. Robinson is president and portfolio manager of Winslow
Management Co., an investment management firm specializing in green
investing based in Boston, MA.