By Ellie Winninghoff

Energy use, water consumption, carbon emissions, and waste. Eco-metrics like these are not exactly the sort of thing you find in a company's financial statements. But in an era defined by peak water and oil, disclosures like these are key to understanding a company's underlying efficiency and resilience-not just its stewardship or citizenship. And as these and other similar metrics become increasingly available, it could create a sea change in the basics of fundamental analysis.

Among the pioneers driving this trend is Michael Muyot, president of CRD Analytics, a New York City-based provider of sustainability investment analytics and indexes. Muyot has aggregated 200 financial, environmental, social and governance (ESG) metrics to create an algorithm to assess and rank the sustainable performance value of public companies.

This ranking, powered by the company's proprietary methodology, is the basis of the NASDAQ OMX CRD Sustainability 100 Index, which celebrated its second anniversary on June 15. The top companies in the index include Merck, IBM, Novartis, Baxter, Credit Suisse, and Banco Santander.

With a two-year annualized return of 13.9% versus 12.4% for its benchmark S&P Global 100 ETF iShares (and 17.8% for the S&P 500,) the CRD index is focused on how ESG factors drive profitability.

"CRD is a bridge between the old way of looking at ESG factors based on a policy and practices focus, and the new way of using results metrics like actual carbon emissions, water consumed or worker accidents," says R. Paul Herman, president of HIP Investor Inc., an San Francisco-based RIA that began offering the index as a managed account in April. "CRD is integrating both, but they weight the results metrics higher. And because it's results-based, it tends to have a positive influence on profitability and shareholder value."

According to Muyot, there are 45,000 listed companies in the world. CRD currently tracks 5,000 total and ranks 1,200 of them. Its universe is limited for two reasons. First, he's tracking only firms that use Generally Accepted Accounting Principles, or GAAP, the American accounting system. Second, companies must meet CRD's minimum requirement for ESG disclosure.

The second requirement is trickier. Thanks to the efforts of the Global Reporting Initiative, or GRI, a multi-stakeholder governed NGO based in Amsterdam that has created the de facto international standard for ESG reporting, companies have started publishing sustainability reports. These reports contain disclosures regarding carbon footprints, energy usage, water consumption, hazardous and non-hazardous waste, employee safety, work-force diversity-the list goes on and on.  

Disclosures Can Vary

But the GRI standards are a framework and a process, and it would be daunting for a company to report all the potential disclosures in its guidelines. Most don't. Nor do they necessarily calculate metrics the same way. Company disclosures regarding carbon emissions, for example, are notoriously different.

And what's material to one company's business might not be as material to another's. For example, at pharmaceutical corporations such as Merck or Novartis, the biggest risk may be chemical ingredients and their associated environmental life cycle. For mining companies, abusive behavior with respect to human rights can end up disrupting supplies.

Muyot says that the GRI walks companies through what sustainability factors are material to their business and maps out what is material to society. But according to Nick Andrews, ESG Analyst at CharterMast Partners, who has consulted for companies as they begin the process of disclosing ESG data and publishing sustainability reports, this may take a few years.

The bottom line is that even if companies publish sustainability reports, they may not be disclosing the ESG information that is most material for their industry or the regions where they do business.

Beyond that, while 80% of the Global Fortune 250 companies publish sustainability reports, only 30% of the Forbes 3000 do so. And until recently, most companies that published this data were based in Europe.

But sustainability reporting is increasing in both Asia and in the U.S. Last November, the GRI established a presence in this country called Focus USA. And the Big Four accounting firms, all of whom have a thriving sustainability practice, are backing the effort.

Meanwhile, Muyot says, his universe of sustainable companies is the best of the best, a judgment he makes based on their transparency regarding ESG factors.

Trying To Build Better Mousetrap

So how does CRD's methodology work? The system looks at 200 metrics-25 for financial, 28 for environmental, and the rest more or less divided between social and governance.

Financials are expressed as percentages or ratios so they can be easily compared. And since most of the environmental indicators are also quantitative (for example, tons of carbon emitted into the atmosphere,) CRD "normalizes" these figures by dividing them by a company's market capitalization. The idea, again, is to render these environmental metrics comparable between companies.

"We've been able to normalize everything," Muyot says. "That's why our system is different."

Most of the social and governance data is qualitative, and CRD expresses this information as yes/no questions. For example, such questions ask if the board has a sustainability committee, or whether the board has a structure for say-on-pay? "These are additional factors that are not a 2.56," Muyot says, "but they actually have a material impact in terms of helping determine which are the most sustainable companies."  

From there, CRD compares each quantitative metric for a company against the same metric for the other 1,200 companies it ranks, and gives it a score of zero to four. Qualitative issues, which have far more metrics and are answered in a yes/no manner, earn either a zero or one.

Then the fun begins. Each of the 200 metrics within what Muyot calls the environmental, social, governance and financial "dimensions" is incorporated into one of five key performance indicators (KPIs). The environmental KPIs are energy, water, emissions, waste and risk mitigation. The social KPIs are product responsibility, community, human rights, diversity and opportunity, and employment quality. The governance KPIs are board functions, board structure, compensation, vision and strategy, and shareholder rights.  

And, finally, the five KPIs for financial data are fundamentals, profit margins, growth rates, financial strength, and analyst estimates.

Since there a total of 53 environmental and financial metrics compared to 143 social and governance metrics, CRD ultimately weighs each of the financial and environmental metrics higher than each of the social or governance indicators. But in the final tally, all four dimensions are weighted equally.

As such, a company's total sustainable performance score represents a true "integrated" value. Or, to put it another way, a triple bottom line of people, profit and planet.

"We stuck with 200 metrics because we wanted a holistic view," Muyot says. "We've created something as pure as it can be."

By that, he means he has made no judgments. But even quantitative analysis has inherent judgments built in. In an era of increasingly scarce water supplies, for example, water consumption is more material to the profitability and resilience of Coca-Cola than it is for Microsoft. In other words, not making a judgment is indeed making a judgment-that water consumption is equally important with respect to the profitability and resilience (or sustainability) of the two companies.

That said, Muyot's efforts are a huge step forward. "This is the most robust methodology [I've seen,]" writes Elaine Cohen, a sustainability consultant at Beyond Business. "It promises to become the gold standard for assessing and ranking the overall sustainability performance of public companies."

A former investment banker and veteran financial reporter, Ellie Winninghoff's writes a blog at: www.DoGoodCapitalist.com. She can be reached at: [email protected].