Profiting From Corporate Social Responsibility

If you're like me, you like to be proud of the companies in your portfolio. It gives me a chance to brag about how a company is changing the world or improving our everyday lives. But you might be surprised to see there is increasing evidence that a more responsible company will get better returns in your portfolio, even in crisis time.

What is CSR?
Corporate social responsibility is the generic term for the way a company thinks about how it should interact with society and the environment. It may be a simple document showing reduced emissions or improved diversity for the year. On the other hand, General Mills (NYSE: GIS) puts out a 100-page document annually covering environmental impact, diversity, community involvement, and a variety of other facts. The issue right now is that CSR is a very unstandardized term as a set of guidelines for comparison. After all, how do you compare the social responsibility of two companies in completely different industries?

Why is CSR important to investors? In some circumstances, it can lead to higher net income for the companies you invest in. For instance, consider all the energy, scrap, emissions, and other inputs that go into making the computer you're reading this article on, much of which turns into waste. If computer companies can reduce that waste by operating more efficiently, it lines shareholders' pockets with profits.

Impact on your portfolio
What I'm looking for is long-term trends that affect your portfolio in a positive way. As much as I like hugging trees and singing Kumbaya, it doesn't matter much if it doesn't enhance your bottom line. Yet even as subjective as CSR may be, there's evidence that it can have a positive impact on your portfolio:

• Every year, Corporate Responsibility Magazine puts out a list called "Best Corporate Citizens." Here you can find a list of companies that are "responsible" based on seven categories including environment, finance, governance, and human rights. In 2009, it reported that in the first nine years of its Best Corporate Citizens list, the CRM 100 Best Companies have outperformed the Russell 1000 by 26%. Not bad.
• At ETH Zurich, a European science and research university, a study called "The Effect of CSR on Stock Performance: New Evidence for the USA and Europe" showed that financial markets value CSR, especially in the United States. A buy-and-hold investor with stocks that have "a high intensity of environmental and social activities" will outperform over the long term.
• Still other research shows socially responsible companies can withstand a crisis better than a less responsible company. Take the No. 34 company on the CRM 100 Best List, Johnson & Johnson, which withstood the Tylenol tampering problem in the 1980s relatively unscathed because it had a good reputation.

So which companies top the list? Here's a sample:

Source: Corporate Responsibility Magazine.

Looking at five of the top 100, you can see how companies that do well in one area don't always excel in others. Eaton struggles in its employee relations rating but makes up for it with a high human rights score.

One further drive for responsibility is active shareholders and employee demands. In 2008, shareholders of ExxonMobil made 17 environmental and social proposals. A Grant Thornton report shows that privately held companies are using CSR as a way of recruiting and retaining employees. That's the positive, but there is also a negative side if you don't do CSR right. This summer, we've seen perhaps the worst example of that.

A warning sign we missed
Looking back, we may have wanted to analyze BP's (NYSE: BP) CSR report and actions a little more closely under Tony Hayward -- not only what's in the report but also how the company was trending.

Ironically enough, Tony Hayward was one of the key proponents of CSR in 2005, giving a speech about corporate responsibility and its increasing importance at BP. This was when Lord Browne was CEO and CSR was gaining more attention. But since mid-2007, under Hayward's reign, the company has gone mostly quiet on the environment, climate change, and responsibility.

Taking a closer look at BP's sustainability review, we can see improvements through 2007 and then weakening of many factors under Tony Hayward's leadership. A number of factors, including contractor fatalities, greenhouse gas emissions, and environmental and safety fines spiked upward in 2009, and hydrocarbon flaring has nearly doubled since 2007. This could have tipped off investors of a changing mindset at BP if we had looked more closely.

My final thought
CSR is not a silver bullet, and being a responsible company doesn't eliminate investment risk all-together. Evidence does suggest it reduces risk and can provide greater returns. What I look for is what the values of an organization are and what employees think of working there. I am much more likely to invest in a company I can be proud of than one I am not proud of. Check out the CSR report of the companies in your portfolio. You might be surprised what you find.

What are your thoughts on CSR as an investor? Give your reaction in the comments section below.

More on responsible corporations:

• Reinforce Your Returns With Social Responsibility
• Transparent Corporate Heroes
• Ditching Dysfunction in Corporate America