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Which Firms Should You Trust?

HIPInvestor | Tuesday March 27th, 2012 | 1 Comment

9th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here.

When HIP was first conceived, there were four elements: Health, Wealth, Earth, and Equality. The first Fast Company scorecard covering 21 of the 100 largest companies rated quantifiable metrics in each of those categories. However, when editor Bob Safian of Fast Company agreed to look more deeply into one industry, Big Oil, the HIP analyst team in conjunction with SVT Group, discovered the need for a fifth element: Trust.

For Big Oil, one new metric was particularly insightful. We created a measure of “riskiness” for each company’s oil investments. We first documented all the countries that were the source of oil production for the top 10. While we sought to weight the production by volume for each country, we found that information was not publicly available. The intent was to test the correlation of risk and return with the openness of the governing approach. Second, we evaluated the “openness” of each political system—from democracy to dictatorship. We relied on the Corruption Perceptions Index by Transparency International for ranking. Somalia, Myanmar, and Iraq were the lowest rated in 2008, while Denmark, Sweden, and New Zealand were the highest rated. Third, we then created a weighted average of the level of participation by each Big Oil company and ranked them.

Which global firm was the least exposed? The answer will surprise you: ExxonMobil. Yes, the same ExxonMobil (NYSE: XOM) who does not rate very highly on Equality did seem to be mitigating its business risk by avoiding oil and gas sources in nations that had more political volatility. On the other hand, BP’s joint-venture investment in Russia’s oil and gas ventures experienced lawsuits by oligarch billionaires, the ejection of BP’s country leader, and negotiation over control of the entity—all since 2003. The dollars at risk are almost half a billion. Mitigating political risk is essential for future stable returns.

The positive response to the fifth element of Trust ensured its place in the evolution of the HIP Scorecard. The beauty of the HIP approach is that it can morph over time as you discover new fundamentals that become leading indicators of higher shareholder value or lower risk.

HIP Trust Metrics

1. Agreeing to Be Interviewed

It goes without saying how transparency and openness to investors can reduce the risk of an equity investment. By showing that they truly have nothing to hide, a company can show investors that they can feel more comfortable in investing in a less risky company. This also transfers to socially conscious consumers who will feel more comfortable supporting companies and products and thus, drive top line revenue, and bottom line profit.

Exercise your right to speak up at annual shareholder meetings. Be in contact with companies as you discover facts that are not transparent. Participate in social networks to make your voice heard. If you are a shareholder in a public company, you own a real share in that firm. Let the company know what you think, how you feel, and what solutions they should consider to build a more HIP future.

2. Third Party Certifications

Third party certifications can help build trust and signal an independent third-party judgment that tends to be fair and impartial. But HIP investors also check the source and the methodology. Positive certifications reduce the likelihood of subpar returns, either because of the product’s higher quality or its increased telegraphing of expectations to the customer. Both increase business value.

A HIP investor selects the certifications that encourage top-line revenue without risking the brand reputation or legal actions. The Malcolm Baldridge Quality Award is presented annually to those companies with top process excellence. The ISO 9001 standard for managing quality added a designation for environmental and energy management systems in 1996 called ISO 14001 (eco). Ford Motor Company (NYSE: F) was an early adopter for itself, saving 1 million gallons per day of water at one of its truck factories. Subsequently, it mandated all suppliers to be certified as ISO 14001 as well. This commitment was another contributing factor in avoiding bankruptcy, unlike GM, which took several years to follow Ford’s lead.

Now there are over 14,000 companies with over 126,000 ISO 14001 certifications, and recently, more certification programs have arisen to help evaluate environmental claims like “natural” or “biodegradable” for products. Currently there are more than 278 certification programs active worldwide, according to EcoLabelling.org. By researching the certifications held by a potential investment, a HIP investor can anticipate the stamina of a company’s market presence.

3. Legal Actions

After years of legal battles, Ecuadorian residents won $9.5 billion for humanitarian and environmental remediation and damages allegedly caused by Texaco, before its acquisition by Chevron (NYSE: CVX). And although mentioned in Chevron’s annual report, it “(did) not believe the report has any utility in calculating a reasonable possible loss.” This liability had neither been accounted nor reserved for in Chevron’s budget.

So by studying the ongoing legal actions, a HIP investor can select for companies that are not at trial for potentially bringing about social or environmental harm, as well as those with low risk for legal financial liabilities. Lower negative human impact seeks higher profit!

4. Lobbying

HIP investors should examine lobbying, as it may reveal a company’s strategy regarding a fair playing field. Three aspects of this metric are important. First, we are watching the importance of this metric grow with the recent Citizens United decision.  Second, the lobbying amounts overall tend to advocate for narrow corporate interests rather than a balance with society as a whole. Third, calculating the amount spent relative to revenue, and comparing to industry competitors, may be indicative of a firm that is seeking special conditions, which could create unfair advantages relative to competition. Use OpenSecrets.org

Goldman Sachs (NYSE:GS) has been one of the top five political donors since over the past 20 years with an average of $1.5 million spent annually. Now with trials and discussions underway regarding their conflicts of interest within their proprietary model, it would be reasonable to assume that anticipated financial reform could interrupt their business model and reduce revenue streams. This is a risk that should be priced into the value of a company, and can be directly represented, and compared to industry peers, though lobbying amounts.

In Conclusion

This discussion on Trust and transparency concludes our foray across five elements of HIP — Health, Wealth, Earth, Equality, and Trust — we have reviewed more than 20 data-driven metrics for you to evaluate as an investor. Each leads to quantifiable business value — from higher revenues to lower costs, from optimal taxes to premium pricing from investors. This financial value can lead to building a portfolio that supports higher human impact and profit.

Integrating a HIP approach into the day-to-day management practices of the company is critical to embedding them into each decision the company makes, from product development to manufacturing to capital spending.

In the next feature, we discuss how HIP metrics link to higher profits and lower risk for the bottom line and investment portfolios.

To navigate this series, please use this table of contents.

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R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois.

NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com

Follow on Twitter @HIPInvestor


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