On Recalls, Valuations and Sustainability


“Guests having Samsung Galaxy note 7 are requested not to use or charge the phone during the flight”. This announcement comes right after the routine safety instructions on the aircraft. I can imagine Samsung being unclothed in terms of value right in front of my eyes. This is a company’s and its investors equivalent of 9/11.

There is a definitive connect between these incidents and company valuations. The direct impact being the penalties, fines, court cases, loss of revenue and promotional spend post these incidents. Notable indirect ramification being a tarnished reputation and erosion of public trust. This has a critical dimension on sustainability. And sustainability accounting captures this connect in a quantified format through its metrics. Typical ‘recalls’ are classified as ‘acute’ meaning that they have low probability of occurrence but have high magnitude impact on company's value, increasing operational risk and ultimately the cost of capital.

We know that most valuation models benefit from predictive indicators rather than post mortem of a specific incident. In sustainability accounting this is captured through building ‘context’ around these incidents or flow of such incidents. This is achieved by supplementing quantitative information with contextual qualitative inputs. The sample questions being 1) Has the company taken a more proactive policy of recalling sooner to deal with potential problems? 2) Is this a developing trend of more significant and wider safety issues?  The analyst while building the future cash flows can incorporate a higher or lower discount rate based on what the ‘quantitative data’ and ‘context’ sheds light on.

It is important to remember that Peabody energy lost a huge amount of value when its share price fell from a peak of $1000 to hit rock bottom at $2. This occurred as traditional coal companies went out of favor with investors and the public due to an increasing concern for greenhouse gases. And the worrying part is that the journey in value erosion did not take much time.

Not only does sustainability accounting attempt to build this in a quantifiable manner that suits the investors, but also puts light on the emerging stage of ESG and Sustainability that the companies in this new world face. The investment models need to recognize this developing scenario and funds, private equity and sovereigns need to figure a way to incorporate this. I found SASB to be an attempt in this direction and addressed the investor’s concerns in a quantifiable and contextual way.

Valuations need to be a mix of financial and quantifiable ESG factors for more effective intrinsic value of an asset.

Valuations need to be a mix of financial and quantifiable ESG factors for more effective intrinsic value of an asset.

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