VALUE: After Hours (S07 E43): Can ESG and Buffett-Style Investing Coexist?

During their recent episode, Taylor, Carlisle, and Todd Wenning discussed Can ESG and Buffett-Style Investing Coexist?. Here’s an excerpt from the episode:

Jake: Todd, are you able to reconcile Buffett– I know all the things– moats and everything that you’ve learned over the years. With ESG, is there a synthesis that can be done there that feels satisfying?

Todd: I think so.

Jake: I would love to hear the thoughts on that.

Todd: Yeah. That’s something that we talk about in my class quite a bit. We go through all of the ESG, here’s how to piece through that, and then think about in the second part of the class, we do economic moat analysis and we do stewardship. And so, thinking about, from a moat perspective, it’s thinking a lot about what the risks are to the company, what are the material risks that might break the moat. So, thinking about, is there an environmental risk that the company has or a social risk that has internal or external relationships?

So, looking at, say, a fast-food company that has poor labor relations, what might that mean when labor gets the upper hand like we saw during COVID. Wages had to go up. What does that do to margins? How does that impact the valuation?

So, one of the things I’ve stressed, is that ESG is not just trying to think about warm and fuzzy feelings. It’s how can we figure out the impacts to the valuation? How does this impact cash flows or how does it impact the discount rate? If we can figure out one of those two things, then we can start applying it to our work. What is the monetary risk that we see in different scenarios if they play out?

I also think generally thinking about companies that are focused on stakeholder analysis from the beginning. So, companies that were thinking about how do I make sure that my employees are thriving and want to work here? How am I thinking about governance, making sure that I’m working for the shareholders and not just working for the CEO? All these things play and come together, I think, with a Buffett like approach. So, finding those stewards who are thinking about these things.

If they were talking about sustainability before it became a big hit in 2020, 2021, that’s usually a sign that they take it pretty seriously. I’ve found that companies that are serious about it and are hitting their goals and targets are generally doing that elsewhere as well. So, if they’re hitting their goals, hitting their targets, putting out measurable targets, they’re not saying like, “Hey, we’re going to be net zero in 2050. Maybe that’s the goal. But here’s how we’re going to get there in the next three years. Here’s the steps we’re going to take.”

They’re not just making these big promises with no accountability. Because as we know, the average CEO tenure is about five or six years. So, they can make these long-term promises. But how are they going to make the case that they’re getting things done towards that? So, companies that can do that, I think, are worth looking at, because that means they’re probably pretty efficient elsewhere in their business.

Jake: So, that’s the reverse cockroach in the kitchen–

Todd: Right. Right. Interesting, I’ve done a lot of studies or research into different studies that talk about ESG risk. One of the things was with governance. So, it’s not so much first decile, top decile. Governance is like a sign of outperformance.

Jake: What does that even mean, though? I mean, like measured how. I’ve seen Berkshire shows up poorly in some of these things and it’s like well– [crosstalk]

Tobias: Like, a board independence or something?

Jake: Yeah, exactly. Somebody’s checklist that they came up with. But it’s hard to see two guys that were more in tune with their shareholders and the whole ecosystem than those two.

Todd: Right. It’s very difficult to normalize everything. But what’s interesting about this research was that didn’t really matter if you checked off all the boxes and you’re in top tier or if you’re in the sixth tier, it was really avoiding the worst, the worst decile. That was where there was a clear signal of issues with performance.

Tobias: What do they do? What do you see in that worst decile?

Todd: So, these are boards that are too small, boards that there’s no separation of the CEO, chairman. There’s not a lot of equity ownership in that group. I had an example from a previous role that I had where I was covering a company that had a huge governance crisis. Did an acquisition, stock fell, I think $4 billion on the day for a one-billion-dollar deal.

Jake: [chuckles] Do no approve.

Todd: Everybody’s had enough. We’re like, “I’m out, I’m done.” I’ve gone along with this for long enough. But yeah, those are the situations that you want to avoid, and that was one lesson to me was there were– Even though everything seemed to be looking good business wise, there was a huge governance red flag. And that huge governance red flag should have been taken into bigger consideration, because once that comes due, once that bill comes due– Talking about the ESG class, we talk about off balance sheet liabilities. When are those coming due and how much are they going to be? And that will have an impact on the valuation.

So, really thinking about avoiding– Charlie Munger talks about you, right? Avoiding stupid mistakes. Avoid the stupid mistakes and good things tend to happen.

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