ESG stocks refer to companies that take favourable environmental, social, and corporate governance actions. The term has grown in use in recent years, largely due to the increased awareness of the need for corporations to take more responsibility for their actions. For example, at the ongoing COP26 summit, the push for businesses to move towards net zero carbon emissions has been vocal. With all of this going on, here’s how I’d pick stocks for an ESG-friendly portfolio.
Picking the ESG areas to focus on
A stock can be considered ESG for many reasons. I want to hone in on the areas that I think are important. At the same time, I also want to look at areas that I believe could offer me attractive share returns.
One area that I think fits the bill is the push to cut emissions. Being net zero means negating the amount of carbon emitted with the carbon being removed from the atmosphere. Given the focus on this field, there is a wide range of companies that I can pick from.
If I want to dig deeper, I’d focus on companies that have already committed to this goal and are already implementing it. Or I’d look at companies in the energy sector that are helping to drive this shift. For now, I would avoid the newer entrants into the field.
Another area for ESG stocks is looking at the supply chain. This looks at sourcing products and labour from sustainable sources and with fair pay. Although this will lead me to look mostly at traditional manufacturing companies, I’ll also be able to find examples within the fashion and mining industries.
Making sure the numbers stack up
Once I’ve picked a few areas, I’ll want to see whether these ESG-friendly stocks are also fundamentally sound. After all, I don’t want to invest in an ESG stock if it’s generating high losses and the share price is falling through the floor! There’s clearly a balance needed here.
With my £1,000, I’ll likely pick three main themes (eg, emissions) and then pick three stocks from each area. Then I’d look at the three companies in more depth and pick the best couple from a financial point of view.
This screening should allow me to find the most suitable stocks for what I want. For example, if I’m looking for income, I’d screen for dividend yields. If I want to focus more on ESG stocks with growth potential, I could look at the price-to-earnings ratio.
From there, I’d look to buy the half-dozen stocks with my £1,000 to finish the setup of my portfolio. ESG themes do change over time, so I can’t just sit back and do nothing. But for a start this would get me up and running.