How Expensive Are ESG Stocks?

By Nicolas Rabener, FactorResearch (@FactorResearch)

Europeans seem far more focused on the environment than Americans, which might be considered unusual given that both share an interest in the outdoors and have great national parks. Perhaps this is explained by Europe’s higher population density, which puts living space at a premium and creates more awareness for the close surroundings.

The Chernobyl disaster in 1986 also likely increased the consciousness for the environment as it affected almost everyone in large parts of Europe. It stopped children from playing on playgrounds and adults from eating certain foods like mushrooms and freshwater fish, which left memorable impressions on how precious nature is.

It is therefore not surprising that 46% of European investors have allocated to ESG, compared with only 28% of Americans, according to survey results from JP Morgan Quant conferences in 2019. Attendees also discussed the risk of an ESG bubble forming as stocks with high ESG scores might become expensive and disconnected from fundamentals as more capital shifts to ESG products.

In this short research note, we will investigate how expensive highly ranked ESG stocks in the US have become by analyzing ESG-focused ETFs.

ESG ETFS & VALUATIONS

We define our universe by selecting ETFs that broadly target ESG in the US stock market and exclude funds with specific themes like gender diversity, vegan climate, or best employers for ex-military personnel.

ESG-focused ETFs in the US manage less than $10 billion of assets, which is surprisingly low given the prominence of ESG in investor discussions. However, these ETFs have been growing their assets under management and Blackrock expects that ESG ETFs globally will reach $400 billion by 2028.

We analyze the valuations of highly ranked ESG stocks by aggregating the price-to-earnings (P/E) ratios of each stock in our universe of 12 ETFs. The simple average P/E ratio across all ETFs highlights that these trade at a lower valuation than the stock market on average, which will be a relief for investors focused on ESG investing.

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