Socially Responsible Investing: Evaluate How a Company Makes Its Money
In theory, a business has no purpose other than to maximize shareholder value. In practice, many companies can maximize shareholder value while also behaving responsibly. If you want to be a socially responsible investor, both should appeal to you.
Businesspeople like to talk about their business models, which simply explain how a company makes its money. A company whose model is to be the lowest-cost provider approaches business differently than one offering luxury goods. A company's business model influences the social choices that a company can make because it affects how it can spend money while keeping shareholders happy. If customers demand the absolute lowest prices, then management may have less leeway to spend money on responsible initiatives and still keep their customers — and shareholders — happy.
But this isn't always the case. For example, Wal-Mart (NYSE: WMT), which uses a low-price business model, found that it could keep prices low by reducing energy costs in its stores and throughout its supply chain, enabling the company to deliver on its business model while improving the environment.
Search for clues in the company's mission, strategy, and tactics
A business model is set out in three parts: the mission statement, strategy, and tactics. An organization that really wants to be socially responsible needs to behave well in all three areas. Ultimately, though, the tactics are most important because they are responsibility in practice. Tactics are where the rubber meets the road.
Although a few companies set these out in a nice brochure, most make you figure out what's what. Also, some mission statements are marketing tactics rather than true guidelines for corporate behavior. Do your research to see whether the management walks the talk in its strategy and tactics.
Many companies have mission statements to describe what they hope to do. The statements are usually just two or three lines long and describe the company's business and operating philosophy at the very highest level: We will be the premier widget company, exceeding customer expectations. We recognize that employees are our number-one asset and that everyone in the organization is responsible for our sterling reputation.
Even though many mission statements rely on clichés to telegraph complex ideas, they still give an indication of what the company's priorities are: Does the company give top priority to the product or the service? Does it emphasize low prices or high quality? Does it make an explicit statement of responsibility toward customers, the community, or employees? Is the mission high-minded (creating a healthy world, for example), or is it practical (being the market leader)? The mission statement is the starting point for all decisions down the line.
Not all companies have an explicit mission statement, but you can get a sense of a company's mission from its different shareholder reports and marketing materials.
The strategy is the plan for putting the mission statement into action. It looks into the future. It isn't updated frequently, but it does change as needed to reflect changes in the company's operating environment. If the company's mission is to offer low prices to customers, then the strategy may be to buy in volume, sell direct rather than through retail stores, or operate with very low overhead.
Tactics are the methods the company uses to meet its strategy. If the strategy is to do intensive research, then the tactics may include such matters as recruiting scientists, choosing promising areas for further study, and applying for patents whenever appropriate. Because the tactics are the specific steps used to run the business, managers may change them frequently to meet the needs of the ever-changing marketplace.
Evaluate the company's goods and services
Many social investors look at the revenue line first. Does the company make alcohol? Pork sausage? Pornography? Weapons? If so, then the investment may not be acceptable under their investment guidelines, and no other factor can change that — not the company's governance, its treatment of employees, nor its environmental practices.
If the company passes that top-line cut, though, you have some more work to do if you care about what a company produces. Here are some things to consider:
Do the products add value to or profoundly change society? Many businesses come about because a visionary entrepreneur sees the opportunity to make a lot of money by developing a product that changes the way the world works. Some are good; some are bad. A bottled water company simply takes something that's more or less free from the tap, puts it into plastic packaging, hauls it to stores in trucks that burn fossil fuels, and charges more money per gallon for it than gasoline costs. It's a sweet business model — it takes a lot of vision to realize that there's a way to charge people $1.49 for something that used to be free. It's not exactly socially or environmentally responsible, but it's a product people are happy to buy.
Others see that huge profits can be made from designing a car that runs on something other than fossil fuels, growing food without pesticides, and developing low-cost computers for people in developing countries.
How is the product used, how is it disposed of, and does the company's management oversee the product portfolio responsibly? For example, toymaker Mattel (NASDAQ: MAT) had a serious problem on its hands in 2007, when many of its toys tested with higher lead levels than were allowed. Consumers were upset, needless to say, and the stock price fell. Investors wanted to be confident that the company was going to make good products that didn't harm the children who played with them.
Investigate how the company gets products to market
Selling a product involves a combination of packaging, advertising, promotion, and distribution; like all things socially responsible, getting the product from the factory to the shop and into the customers’ hands can be done in responsible, neutral, or irresponsible ways.
Packaging and distribution are closely related matters of sustainability and cost control. Is the packaging designed with reused and recycled materials that can be easily reused or recycled again, or is it made from all new materials? Likewise, how efficient is the supply chain? Can the company get goods from place to place using a minimum of resources?
You also should think about who buys those packaged goods after they end up on the shelf. Are you comfortable with the customers being targeted by the advertising and promotion campaigns? Some investors aren't comfortable investing in companies that market to teenagers with R-rated catalogs that sell expensive products to people who can't afford them, or that push goods too aggressively toward children.
Finding out about a company's marketing practices is probably easier than investigating almost any other aspect of its business, because the goal of marketing is to grab attention.