Cash Flow Valuation and ESG

Environmental, social, and governance (ESG) data expand the objectives of the organizations so that they eventually achieve sustainability and, by doing so, create value both for them and collaterally for several of their stakeholders. However, this value is not easy to capture, let alone assess. Indeed, ESG factors prioritize long-term sustainability over short-term profitability, with a clear asymmetry between the certainty of ESG-aware investments and costs to incur on the short term and the uncertainty of future returns, in both magnitude and timing. Among the many valuation techniques, discounted cash flow (DCF) is an approach of interest when dealing with ESG specifics. For starters, it explicitly processes forecasts using both short-term and long-term horizons, thus enabling consistency of ESG effects over time. Secondly, not only does DCF account for the individual ESG strategy embedded in the company’s forecasts but also for the industry-systematic risk, which can be ESG-sensitive through the cost of capital. Alas, the implementation of DCF reveals tricky to implement with total consistency for all its parameters and inputs. This chapter focuses on the many issues and sensitivities of DCF when dealing with ESG data.