In this episode of Industry Focus: Consumer Goods, Emily Flippen and Motley Fool analyst Maria Gallagher bring us all the details on ESG. Millennials and Gen Z are putting more emphasis on sustainability, and they are willing to spend more to get products that live up to their standards. This, in turn, is leading companies to adopt ESG practices more and more. Find out how this segment is going to grow in the future. Also, we have some ESG-friendly stocks for you.

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This video was recorded on March 2, 2020.

Emily Flippen: This podcast is airing on Tuesday, March 3, and I'm your host, Emily Flippen. Today is going to be a fun one in the Consumer Goods space, not just because we're covering a really interesting topic but also because I'm joined in studio by Motley Fool analyst Maria Gallagher, who is going to talk to us about one of the biggest trends that we've seen in consumer goods, ESG. Maria, thanks for joining.

Maria Gallagher: Thanks for having me.

Flippen: Yeah. ESG. I know you spend a lot of your time looking at it, and it's wonderful, because I think it's an area that a lot of Fools here don't really cover, and it should be covered more, but it's been in the spotlight a lot for consumers for what feels like a really long time now. It still makes many people confused though, because there really is no good definition for what ESG means. When I think about why it's kind of topical right now, I get brought back to the Davos 2020 Summit, when it seemed like the idea of businesses "maximizing profits" was starting to give way to businesses that wanted to be good citizens.

So yeah, besides being an all-round impressive analyst I know you spend a lot of time thinking about these topics. So I guess the question I want to ask first is just like, "What is ESG?" It might be like beating a dead horse at this point, but I know the definitions for different investors can be dramatically different.

Gallagher: Yeah. So ESG stands for environment, social, and governance. So it's an inclusive screening that helps you look at companies. So instead of exclusively saying, "I don't want to look at sin stocks," which are generally tobacco and gambling and alcohol, it's saying, "I'm going to look at companies with these criteria and see how they interact with the environment, how they treat the world around them, their social aspects, so how they treat their employees, the company culture, the pay." Stuff like that. And then the governance, "How's the Board treated? How are the senior executives treated?" And so, when you look at all of those factors, you can decide then if you believe it is a company with high standards or low standards within that ESG space. So it really could be anything.

Flippen: And for consumer goods, in particular, I realize that ESG might be a little different for goods that are actively consumed by people. So how do you look at ESG in the confines of a consumer goods lens? Like, what should we be looking for?

Gallagher: So when you look at the E, you can look at things like water use, energy use, carbon footprint. So if they're e-commerce-based, I think that's a really big thing is their carbon footprint. And then when you think about the social and the governance aspects, thinking about things like worker treatment and especially with those bigger companies, the safety conditions of factories, where the factories are based, and then the worker pay and things like that. So kind of, lots of different areas to explore with the consumer goods.

Flippen: I can't help but think that this has been an issue for a long time now, though. You mentioned, like, worker pay, and you know for a long time, child labor was even legal here in the U.S., and it didn't seem like people were concerned about it; at least not to the point where it would influence a lot of their investing decisions. So what's causing this renewed focus on ESG, at least in the consumer goods space?

Gallagher: That's interesting. So millennials are now the largest spending portion of the population. So there are over 83.1 million millennials in the U.S.; two of them are sitting right here. And millennials are actually much more likely to emphasize sustainable spending. So 66% of millennials say they're willing to spend more money on labels that are sustainable; 75% of millennials say it's important that brands give back to society instead of just making a profit. And so, that's true for millennials and then also Gen Z, which are increasingly the consumers of the economy. So I think it's more reactive from the companies instead of proactive, it's the consumer ideology is changing and so then the companies are reacting to that.

Flippen: Yeah. You say there's two millennials sitting right here, that's completely accurate. And maybe I am a bad millennial, but when I think about my consumption trends, I wonder if I'm more that person. I don't tend to think about ESG when I'm making consumption habits, at least not explicitly, and I think about a lot of these retailers like TJ Maxx and Ross, we talk about it a lot on this Consumer Goods Industry Focus podcast. And those businesses performing really well.

So when you think back to your consumption, in particular, how do you see this playing out in the average, let's say, 25-year-old millennial female's life?

Gallagher: I think that millennials have this interesting juxtaposition where we love a good deal but we also don't want to actively hurt the world around us. And so, I think something that's interesting to me is a lot of my friends care -- so, it used to be an ESG would exclude things like the sin stocks, like I was saying, alcohol, tobacco and gambling, but a lot of people I know, those things aren't necessarily at top-of-mind, the environment is a lot more top-of-mind. So I've realized, for myself, when I buy clothes, I tend to try and buy sustainable brands. So I will spend a little bit more if I think that what the company is doing is helpful for the environment or if they use recycled materials or if they do something like that, I am more willing to buy that brand.

Flippen: Yeah, I want to get into, I guess, the perception you're getting about, a little bit later when we talk, but for now, what are some companies that you see that are really doing ESG right and capitalizing on this? I hate to call it a trend, because it's so much more important than just a trend, right? I mean, it's our future, it's our livelihood. But what companies do you think are capitalizing off of this movement? Let's say that.

Gallagher: So Etsy (ETSY -2.35%) is one that comes to mind pretty initially. So just in case anyone doesn't know, Etsy is a consumer marketplace for homemade items. So you can get a table there, you can get a dress, you can get anything, and you can connect with sellers from all over the country all over the world. And so one of the things with Etsy is 87% of store operators are female, and 75% of the operators consider their shop a business. So when you're supporting businesses through Etsy, you're supporting a female, which is exciting usually, and then they also offset a 100% of their carbon emissions. They plan to power their operations with 100% renewable energy. And then through that S and the G, the company itself, actually 50% of employee base is female and 50% of their board and majority of their executive team are actually female, so.

Flippen: So you're telling me that, I actually have been consuming ethically then. So whatever I buy something off Etsy, I'm actually making not just the fun choice, but the right choice?

Gallagher: Yes. [laughs] You have my stamp of approval for using Etsy.

Flippen: And what about fashion, what should I be looking for when I'm buying clothes?

Gallagher: So the cyclical economy is on the rise because online resale is actually the fastest growing segment of the retail market. So it's projected to grow to $51 billion by 2023. And The RealReal (REAL 5.34%) is a company that's really capitalizing on that.

Flippen: Wait, The RealReal?

Gallagher: The RealReal.

Flippen: Do you know the ticker for The RealReal? Is it REAL?

Gallagher: It's REAL. Yeah.

Flippen: [laughs] Should have expected nothing less.

Gallagher: [laughs] And so, what it is, is it's actually another online marketplace but it's for consigned luxury clothing items. And so, something with The RealReal is the greenhouse gas emissions and the energy savings of 87 million metric tons on top of you being a part of that consumer cyclical economy. So instead of buying fast fashion, you buy things that are already preowned, which is very good for the environment. So I think that's a pretty good one. And 60% of millennials also cite environmental concerns as one of the reasons to shop resale, so it's pretty popular.

Flippen: Oh, that's awesome. So when you're buying stuff, there's always an easier way, so when you're looking to purchase things online, Etsy is very clearly a company that has benefited from ESG trend and is doing ESG well. When you're looking to buy clothes, The RealReal -- which I still don't believe is a real company, but it is -- is a great place to go when you're looking to get consignment luxury goods. What about other things that you might think are causing, I guess, bad emissions? I think cars are the big one.

Gallagher: Yeah, so kind of a controversial topic all the time. But Tesla is actually --

Flippen: Oh, you're going to get some tweets at you now. [laughs]

Gallagher: [laughs] -- this is not a stance on pro or positive or negative Tesla, the company, but just what they're doing for the environment is very positive. So they're pushing electric vehicles to the forefront of the minds of car consumers. And then it's, kind of, pushing other auto manufacturers to keep up. So Ford, Volkswagen, all of these companies are now saying they're going to have electric vehicles to compete with Tesla. So whether you like Elon Musk or hate Elon Musk, like the stock, dislike the stock, you can't really argue that they're not making an environmental impact, which I think is a net positive.

Flippen: Yeah, I talked about Tesla a lot on podcasts, which is usually always a mistake. "Usually always" is counterintuitive to put it, but it's always a mistake. No. But you say, it's not a stance on the company itself, but I actually you think the point that you make about it being a sustainable business is part of the biggest selling point for a company like Tesla, is the fact that these companies -- and it's not just Tesla, The RealReal, Etsy, companies that are taking ESG back into their own hands are looking forward 5 years or looking forward 10 years, looking forward 50 years, which for a lot of investors might be too long, but for someone who is a millennial, that's a perfectly feasible investment route for them, a 50-year investment horizon. It's kind of aggressive, but it's possible.

These are companies that are looking off into the future and trying to build their businesses based off the future that they see happening. So I actually feel like ESG investing, regardless of what the numbers say, it's, kind of, taking a forward approach to your investing strategy.

Gallagher: I would agree with that. And I think it's part of the competitive advantage, is if a company doesn't have to think about spending all this money on PR or because of scandals like Nike, or if they don't have the high employee turnover because they have created a culture that makes employees happy. This is actually kind of a sort of a competitive advantage when we look at these kinds of companies.

Flippen: And with that in mind, what are some companies that are really doing ESG poorly, that are maybe doing the opposite of looking forward five years or looking back five years and trying to build a business model off of what's been historical precedent?

Gallagher: I think one that springs to mind, for me, with that would be a company like General Mills. So General Mills has this really long history with these brands that are pretty iconic but aren't necessarily the healthiest. And they tried to pivot a little bit from that. They acquired Blue Buffalo, they acquired Annie's, so they're trying to go into the dog food business and also the healthier snack food options, but it hasn't worked super well. They had steady revenue decline from 2014 to 2018. Blue Buffalo has helped out a little bit, but I don't necessarily know that their legacy brands are going to be as popular in the next hundred years as they were in the first hundred years.

Flippen: Is this just like a change in consumption habits? Is it making a conscious choice to eat healthier food? Or is it just a decline in some of their legacy brands that people are not necessarily making healthier choices, they're just not interested in General Mills legacy products?

Gallagher: I think it's probably a combo of both. I think a big part of it is people buying things online too. So if you're shopping online or you're losing that shelf space, which is a big part of the brand recognition would be on that shelf. And if you're just buying all your stuff online or you're buying just the Whole Foods brand or whatever the store you shop at, if you just buy that organic brand or their regular brand, you might just not use the General Mills legacy stuff.

Flippen: Yeah, private labels have definitely been on the rise. I can't help but look, you shared your notes with me, and I can't help but look, you called out Oui, the Yoplait yogurt. And I had to say, I'm a big fan of Oui. But I noticed, the last time I was in the grocery store, they had an almond milk-based yogurt, and I tried to buy it, and unfortunately, the person who was stocking the shelves was throwing them out because he said they had all expired.

Gallagher: That's unfortunate. I've had almond milk yogurt and I've had cashew milk yogurt.

Flippen: And you don't -- your face is not --

Gallagher: I mean, I don't think they're good but. I just think -- I mean, it's smart to try and pivot to people. So I'm lactose intolerant, so I have to eat those things. But I mean, they're not yummy. I would rather not be eating them. I don't know anyone who's really jazzed about almond milk yogurt.

Flippen: So part of the struggle for General Mills, and companies like General Mills -- I hate to call them out just totally independently, because, I think, it's maybe an overarching trend with a lot of these legacy food players. You know, thinking about alternative meats even. A lot of legacy food players are trying to get into that segment of the market, because they see optionality there. It's just trying to predict where consumption is going with a lot of people, and it seems like a lot of consumers are choosing to be more conscious, whether that be health, whether that be environmental, in the choices that they're making.

Gallagher: Definitely yes.

Flippen: And getting back on clothing, because, you know, I kind of called out TJ Maxx and Ross, and I don't want to make it seem like they are necessarily bad, because I realize what they're doing is taking leftover inventory and trying to sell it. And there's an argument to be made that that's actually good for the economy and for the environment, because it's preventing those clothes from being wasted otherwise. But what are some, I guess, retailers and fashion, in particular, that you see doing ESG really poorly?

Gallagher: Yeah, I would agree with that that they're actually helping the environment by saying, "You know, we're not going to waste these clothing, we can give it to you at a discounted price." So I mean, Forever 21 filed for bankruptcy in September, so that's a pretty immediate thought is, Forever 21 and the fast fashion just kind of doing it as fast as possible and not really regarding the factories and the consumer habits. And then, I mean, Nike is kind of controversial because they do make recycled things and they have had some positive impacts, but then also they had some controversy with things like child labor and the way that they treat their factory workers, and so being in the public eye is, that one's kind of a mixed bag, I would say, with Nike.

Flippen: Yeah, and gosh, absolutely, horrible. But one of the things we talked about a little bit earlier before we go into stocks was the perception that you had about a lot of these companies, and Nike, I think, struggles with perception to an extent. But it's something that I think is really important to ESG investing because the perception that companies have in consumers' minds can drive sales, whether that be the perception that they're doing something to help the environment, they're doing something that's in line with ESG principles, but not actually? Or if they actually are doing stuff that's really good but not doing a great job of advertising it, so you don't make those conscious decisions in your mind to consume.

But a lot of focus has been on three companies in particular, which, I guess, have really gotten into this space regarding climate change, that's Amazon, [Alphabet's] Google, and Microsoft coming out with these robust sustainability plans that are essentially saying that they're going to improve their carbon footprint, most of them, to reach carbon neutral -- something they call carbon neutral -- over the next 5 to 10 years. So what does that mean, and is it a good thing? Does it change the way it's perceived in people's minds?

Gallagher: So carbon neutral, the basic idea is that when an organization is trying to take out as much carbon dioxide from the atmosphere as they put into it, so that can be done by things like planting trees to offset carbon emissions, and so the goal is to kind of just achieve that net neutral to do as much good as you do harm.

I think it's interesting, because the three Rs are reduce, reuse, recycle, and they're listed in order of importance. So reduce is actually the No. 1 most important thing we can do for the environment. And so I think it's important to note that this isn't actually reducing any of their emissions, they're not doing anything to stop that or some of them might; I haven't looked too far into that. I know sometimes part of the plans is actually reducing carbon emissions. But just offsetting carbon footprint is not actually reducing it, it's just trying to kind of make it a net neutral.

Flippen: Yeah, and I think that while reducing, like you said, is probably a big part of this, I think the bigger part in reaching carbon neutral is probably getting those offsets. Because a company like Amazon is really never going to be able -- at least not feasibly over the short- to medium-term horizon, going to be able to reduce all of the emissions that they produce when they're shipping millions of packages to consumers every single month. So it's really challenging to get that first R.

But why do you see these, especially these tech companies sell a lot of consumer goods, but why do you think they're making the move to try to become carbon neutral?

Gallagher: I think a lot of it's the public perception. So consumers really care about that and they really want it. And it's interesting because it's another kind of juxtaposition where it's, "I want a company to be doing good things for the environment, but I also want what I'm buying from Amazon Prime to be at my doorstep tomorrow." So you want to feel good about what you're doing, and so if these companies get in front of it, you can say, "Okay, I maybe am not helping the environment by doing this, but I know this company is helping the environment," so it will just kind of increase consumption, and it would just increase -- like, we were talking about that public perception where -- especially with tech, there is a lot of villainizing of big tech right now, I think. And so having some sort of positive thing is helpful to these companies, to be like, "No, we're not doing all bad things."

Flippen: [laughs] And that brings up to mind that concept of greenwashing, though. And I mentioned it earlier, but it's essentially companies that will bring firms in to make small and unmeaningful changes to their businesses with the purposes of having a great PR campaign that says, "Look, this company is now so ESG friendly, it's so green." And I wonder -- we see a lot of this happening. I'm not saying that that's what Microsoft, Amazon, and Google are doing, by any means, I expect that they actually are making substantial changes even if that is just buying carbon offsets.

But what are a couple of steps, I guess, before I leave it here, what are some steps that consumers -- so, people like me who want to consume an ESG and want to invest in ESG-friendly fashion, but don't really know how to get started -- what can we do to take that first step?

Gallagher: I think the first thing to do is just start doing your research. So don't really just take the companies by their word, don't just read a headline that says, "We're doing this wonderful thing for the environment." Actually, read what they're saying and read what they stand for. A lot of companies will have sustainability reports you can read. You can see if those sustainability reports are through high standards or if they're just kind of saying whatever they want. So those are pretty good things to do. Just do your research and figure out what's something you really care about, like, do you care more about the environment, do you care more about the treatment of workers, what is this thing that you really want to emphasize?

Because, it's unfortunate, but there's no perfect company, there's no perfect investment. So you have to just kind of weigh the positives and the negatives of every company as you're consuming it, as you're investing in it to say, "Do I think they're doing more good than harm?" "Do I think that they know what they're doing that's harmful and they're trying to implement steps to help that?" It's really up to your discretion as a consumer and as an investor, but just kind of think through how you want to spend your money, because it's kind of your power. And this economy is just how you spend it.

Flippen: Thanks for joining us, Maria. You've given me a lot to think about.

Gallagher: Thanks for having me.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out, shoot us an email at [email protected] or tweet us @MFIndustryFocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for his work behind the glass today. For Maria Gallagher, I'm Emily Flippen. Thanks, and Fool on!