Our approach to applying sentiment analysis to sustainable opportunities
We believe sentiment analysis can be used in three ways:
1. Find underappreciated long-term winners where the market is fading these tailwinds too quickly.
The stock market tends to be focused on the shorter term, anchored to old growth rates and less efficient at discounting inflections in long-term growth rates. However, the long-lasting tailwinds we see in these companies can show higher growth potential over the longer term. Conversely, where our analysis shows that a stock’s growth rate is fading faster than the market expects, we would seek to avoid it.
A good example of anchoring would be a company which is a key enabler of electrification of buildings, transport and industry. Its low- and medium-voltage electrical products and software play a big role in the upgrading of buildings and electrical grids. A number of its solutions could improve energy efficiency by up to 50% and reduce energy costs by 30%, but this potential is currently not factored into the company valuation, because of anchoring to past legacy issues.
2. Identify companies that are promising for the long term but hampered by short-term cyclical concerns.
Short-term cyclical concerns may cloud a positive long-term picture when it comes to not only fundamentals but also decarbonisation and wider sustainability potential. From a behavioural perspective, loss aversion often leads investors to avoid cyclically challenged companies. This bias can lead to re-rating opportunities when the short-term cyclical environment improves, and the long-term tailwinds become apparent.
An example of loss-aversion bias would be a shipping equipment company which has developed marine engines that can run on green fuel. It has suffered from the downturn in the marine cycle, but as we approach the trough of the cycle it is starting to benefit from the shipping industry’s structural need to reduce carbon emissions. The company’s fundamentals are intact, with a solid balance sheet, and the valuation is attractive. However, the upside potential in the company — both from a sustainability and a financial perspective — remains broadly underacknowledged by the market due to these shorter-term concerns.
3. Manage risk
Investors tend to flock to stocks that may appear to be strong financial and sustainability winners. Yet this “safety of the crowd” bias may mask fundamental flaws in the positive investment case that supports current valuations and third-party ratings.
An example of safety of the crowd bias could be some of the wind turbine companies where the compelling sustainability case has led to a premium rating for the stocks which may mask any fundamental issues. In some cases, stocks have underperformed as a result of a growing dissociation between weakening fundamentals and a persistently strong sustainability case. We would avoid such stocks, given the risk they pose to clients’ portfolios.