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Investors Business Daily
Investors Business Daily

ESG Investing: Surprising Companies At The Forefront Of Green Innovation

The 100 Best ESG Companies on IBD's fifth annual list of green innovation leaders may surprise some readers. Yet that's not a bad thing for those interested in ESG investing and green technology.

Producing this ranking would be pointless if investors already knew which companies they wanted to consider for their portfolios and ESG investing. We want readers to discover public companies that they hadn't thought of before but which nevertheless do an admirable job living up to environmental, social, and governmental criteria — ones that also sport superior technical and fundamental stock ratings from Investor's Business Daily.

It's easy to overlook such companies. One obvious reason is that the ESG umbrella encompasses a disparate array of qualities. Like the man with his feet in the oven and head in the freezer but who on average feels just fine, a single ESG rating can gloss over a wide range of qualities.

The E (environmental), S (social), and G (governance) silos are further broken down into dimensions. They are business model and innovation, the environment, social capital, human capital, and leadership and governance.

Take Prologis, which is on this year's IBD Best ESG Companies list. This industrial real estate developer ranks very high, in fourth place (out of 100) on the environmental dimension. Yet the firm is in 83rd place along the social capital dimension. Its overall rank is closer to the middle of the 100 top companies, at 44th.

AppFolio, meanwhile, scores at the bottom of the list of 100 for the environmental dimension. But the cloud-based property management software and services company is in the top third for its leadership and governance efforts. Overall it's in 48th place — very close to Prologis.

ESG Investing: Best Companies Methodology

To build the 2023 100 Best ESG Companies list, we looked at each company's environmental, social and governance sustainability score created by Dow Jones Newswires, a sister company of IBD. These scores capture a broad spectrum of information on the ESG profile of more than 6,000 global companies.

On Aug. 24, IBD asked Dow Jones for an ESG-scored list of all the U.S.-traded companies it tracks, a total of 2,067. The list was cut to 1,559 companies on Aug. 25 by removing nonpublic companies and companies with stock prices below $10 a share. We also removed any companies that lacked sufficient data to create an IBD Composite Rating, which compares a stock against other public companies across five fundamental and technical performance metrics.

We further qualified the ESG investing list by removing those companies that did not meet or beat the S&P 500 in the past five years. Then we selected the 100 with the highest IBD Composite Rating — all with scores of 81 or better, putting them in the top 20%. To break any ties, we looked at companies' Relative Strength Rating and then, if needed, their EPS Rating. Finally, we ranked the 100 companies by Dow Jones' ESG score.

Read Our Full Special Report On IBD's 2023 100 Best ESG Companies, Our Feature Story On Green Patent Innovation And See The Full List Of Winners.


3 Best ESG Investing Companies

Topping the list this year is Microsoft. Applied Materials took second place, and in third place is Woodward, which makes aerospace and industrial products. Verisk Analytics, a data analytics firm that serves the insurance industry, and Mastercard finished fourth and fifth respectively on the 100 Best ESG Companies list.

How Energy Companies Drive Green Innovation

Peruse the full list, though, and some names may startle those interested in ESG investing. The array of ESG criteria only partly explains why investors may overlook companies that deserve consideration.

Some companies that might seem to be the antithesis of ESG actually are at the forefront of the green technology revolution to address climate concerns, new research suggests. The implication is that investors seeking to mitigate climate change need to look closely at companies that might appear to be more problem than solution.

The National Bureau of Economic Research this summer circulated research titled "The ESG-Innovation Disconnect: Evidence from Green Patenting." Lauren Cohen of Harvard Business School authored the report, along with Umit Gurun of the University of Texas at Dallas and Quoc Nguyen of DePaul University. Many of the companies they found to be at the cutting edge of climate change mitigation are among those that ESG investors would least expect.

Patents Analyzed, Focus On Green Tech

The professors analyzed all patents awarded to U.S. publicly traded companies since 1980. They focused only on those patents classified as "green" according to criteria laid out by the International Patent Classification system of the Organization of Economic Cooperation and Development.

They found most "recent green patenting is not driven by highly rated ESG firms — firms that are commonly favored by ESG investors and funds. It is instead driven by firms that are explicitly excluded from ESG funds' investment universe" — fossil fuel companies especially.

For example, the professors found the following oil and gas companies to be at the forefront of green innovation: ExxonMobil, which is the 11th largest owner of green patents, Royal Dutch Shell, the 18th largest, and BP, the 27th largest. Other top green technology patent holders were ConocoPhillips (28th largest) and Chevron, (30th).

Traditional Energy Sector's Role in ESG Investing

So readers should avoid any knee-jerk reaction to seeing in this year's IBD's Best ESG Companies list several traditional energy companies in the coal, oil and gas, and mining industries. 

You need to dig below the surface to know for sure the best ESG investing opportunities. (The five big oil and gas companies mentioned above that are leaders in green tech patents aren't on the list. That's because they didn't have the minimum IBD Composite Rating to make the list or weren't included in the original Dow Jones dataset.)

But among our list of the three best companies within the five ESG dimensions, Marathon Petroleum tops the environmental category with a score of 73.09. Marathon is in seventh place overall.

Caterpillar, the manufacturer of construction and mining equipment, is in sixth place in the IBD Best ESG Companies list for 2023. Caterpillar includes Caterpillar Global Mining, which also provides mine efficiency and productivity systems. According to the professors' report circulated by the NBER, it is the 20th-largest owner of green patents. Also read about the Best ESG Companies In Each Of Eight Industry Categories.

Or take Air Products & Chemicals, which manufactures and distributes atmospheric gases. It's the 36th-largest holder of green patents, and stands in 18th place in the IBD list.

Read How ESG Reporting Has Become A Critical Tool For Investors And Companies

Marketing Vs. Actual Climate Change Mitigation

Readers may worry that the professors' findings reflect "greenwashing" by fossil fuel companies. That is, they may suspect the companies are marketing themselves to be at the forefront of green innovation without actually doing much to bring about change. Their green patents might have only minor real-world significance, for example, created just to run up the total they can brag about in their annual sustainability reports.

The professors discounted that possibility. They found that the green patents produced by energy companies are more likely to be "blockbusters," as defined by how many times they are cited in peer-reviewed literature. If anything, these firms' green patent production appears to be less motivated by greenwashing than that of non-energy firms.

Another possible objection is that fossil fuel companies might be creating so-called "patent thickets." The professors describe those as a "dense web of overlapping intellectual property [rights, created] … to prevent others from commercializing green technologies." Patent thickets are common in the pharmaceutical industry, and the professors turned to a methodology created in that industry to detect them.

The researchers found "more evidence of thicket-like behavior among green-patenting firms outside of the traditional energy" than inside.

Green Tech Patents' Significance For ESG Investing

As a final test of whether fossil fuel firms' patenting activity has real-world significance, the professors correlated green patents with the wattage they produce of alternative energy. They found that "fossil fuel companies' green-energy patents produce more kilowatts of alternative energy than those of green-energy firms." This suggests "fossil fuel companies are utilizing their green patents, putting them into actual production now rather than shelving them for future use."

Fossil Fuel Firms And Green Tech

Is climate-change denialism behind this new ESG investing research? In an interview, Cohen said this is not the case; he and his co-researchers consider global warming to be a significant issue.

"It's precisely because we see it as such an urgent threat that we focus on those efforts that are able to make an actual difference to the climate. That's why it's important to point out that, by redirecting capital away from the very firms that are at the forefront of technological innovation to mitigate global warming, well-intentioned ESG investors may not be making as big a difference as they could otherwise — if not making matters worse."

Cohen said his and his co-authors' research is not motivated by a desire "to defend the fossil fuel companies or hold them out as paragons of virtue in the climate space." They write in their study that they view fossil fuel firms as "profit-maximizing entities with the aim of being long-lived global energy providers for decades (or even centuries) to come, irrespective of what that energy source might be." Because these firms have this as their motivation "that aligns them with investors who want to genuinely support climate change mitigation."

Those interested in ESG investing may wonder how it came to pass that so many ESG scoreboards missed the leading role that some traditional energy companies are playing. One big reason, Cohen believes, is what's known as a "measurement trap." That's the (typically unconscious) belief that what can't be measured isn't as important or significant as that which can be measured.

Measuring Green Innovation In ESG Investing

Measuring companies' green innovation is difficult. Before this new research, few ESG rating agencies would have known how to go about measuring it, if they even thought of it in the first place. This and similar habits of thought might have led them to focus instead on that which is more easily quantifiable. That includes factors such as companies' self-reported greenhouse gas emissions, the diversity of their boards of directors, and so forth.

This points to a broader ESG investing lesson that should be drawn from this new research. "There no doubt are other factors besides green innovation that are equally important to climate change mitigation yet equally difficult to measure," Cohen argued. "And we shouldn't overlook them just because of that difficulty."

The bottom line? For ESG investors, "ESG ratings should be the beginning of investors' search for companies that can make a difference in the world, not the end."

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