How HIP are Your Holdings? Score Them for Human Impact + Profit

19th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here. Do you read nutrition labels at the grocery store, or consumer reports for a product you hope to purchase? Have you ever used sites like Yelp.com for store reviews, Trip Advisor.com for travel reviews, or Kelly Blue Book for vehicle buying, or GoodGuide for health and ecological product profiles? Then you are familiar with the process of comparing and contrasting products and companies in order to determine whether or not they may be worth your investment. At HIP Investor, we make investing choices based on a full and comprehensive picture of all risks and opportunities, in the short- and long-term. A core "HIP portfolio" has typically focused on an index of 100 companies (e.g. the universe of S&P 100) to be appropriately diversified, keep risk lower, and position for potentially attractive returns. A HIP Portfolio also seeks to increase measurable human, social and environmental impacts. When companies are rated on “how HIP” they are, those leaders strive to “race to the top” and laggards seek to “avoid the bottom.” Competitive human nature kicks in and the total impact starts to rise. Furthermore, this competitive rating approach creates a drive by innovative companies to provide solutions that deliver even higher environmental, social and human impacts. Through this series of features, you have learned how the HIP methodology works. Now you can create a HIP Scorecard for your portfolio company-by-company. Based on the share of products that are HIP, the quantitative scores of human impact, and the management practices ratings, you can calculate your portfolio’s HIP Score. Additionally, you will be able to compare two or more companies in the same industry to construct an “industry face-off” in order to determine the best fit for your portfolio. Here are some components of the HIP approach and the steps to create a HIP Score: Step 1: Evaluate Products For each company you evaluate, seek out the products and services that are solving a human need. The goal is to understand the company’s offerings to customers. What human need are they serving? How are they creating measurable impact? How much revenue and profit are those products driving relative to the rest of the product lines? Calculate the share of revenue from positive-impact products. Contact the company to ask how it currently reports the revenue linked to positive-impact sectors of its product portfolio — or when it will start doing so. The ratio for HIP Products is: (a) The value of revenue associated with products creating net positive impact (in the case of GE’s (NYSE:GE) ecomagination products, this totals $17 billion for 2008); divided by (b) the total revenues of the company (for GE that year it was $175 billion). So, in this example, we divide $17 billion by $175 billion, and get just under 10 percent. This is the share of revenue from HIP Products. The maximum score is 100 percent, of course—but no public company has hit that magic number yet. Step 2:Analyze Human Impact The goal is to understand how a firm creates positive impact. Read the company’s annual report and quarterly earnings statements, investor presentations at shareholder meetings and analyst meetings, and its sustainability scorecards or corporate citizenship reports. Check out third-party sources, like the Carbon Disclosure Project for greenhouse gas emissions totals. Use a common denominator (like revenue or employees) to standardize the comparisons, where appropriate. In addition, the scoring for each metric should generally take into account how each company compares within its industry (for example, carbon emissions for financial companies would be much lower than energy firms or utilities). At HIP Investor the Human Impact Score is a critical measure, because it gauges the true results of a company’s impact—which connects directly to how that firm makes money. For example, carbon emissions are a direct product of a company’s operations and energy usage. Lowering emissions can result from using less energy or creating more energy efficiencies. Take the full GHG emissions, like 1,054,749 metric tons for J.P. Morgan Chase (NYSE: JPM ) in their 2008 CDP report and divide by its revenue ($112 billion, in this example). That ratio of 9.4 GHG per $1million of revenue compares favorably to Bank of America’s (NYSE: BAC) slightly higher 12 GHG per $1million for 2008. Since GHG intensity means fewer emissions per dollar of sales—and contributes to more human impact—it is a useful HIP factor. J.P. Morgan Chase would rate more highly since it has a more advantageous position by being more efficient. Step 3:Understand Management Practices Recurring successes result when there is a methodical and systematic approach. CEOs who cite sustainability as a business strategy, like Jeff Immelt (“Ecomagination” and now “Healthy-magination” at GE) or Indra Nooyi (“Performance with Purpose” at PepsiCo [NYSE:PEP]), are more likely to recruit great talent, impress customers with new products and attract sustainable investors. The more systematic the management approach, the more likely that firm will gain from sustainable, profitable growth. The HIP Management Practices Rating assesses a company on five characteristics: vision, metrics, financial alignment, accountability, and decision-making. Selecting from five multiple-choice answers (and using a 5-point scale) in each of these five categories, a maximum score of 25 is possible. For example, in Management Practices, United Technologies (NYSE:UTX) rates 24 out of 25. In 2007, Walmart (NYSE:WMT) rated an 18 out of 25 for Management Practices; by 2009, Walmart rated a top-notch 23, for accountability, measures, and HIP decision-making. The scores can—and should—improve over time, as companies’ management practices become more sustainable and HIP. Creating your HIP Score: Here is where being a HIP investor becomes even more exciting. First you need to decide how much weight should go to the answers in each of the three strategic areas. For example, you can try 15 percent for Products, 60 percent for HIP measures, and 25 percent for Management Practices. These weights should reflect your evaluation of the metrics relative contribution to future outperformance. In the HIP metrics, pick the sub-weights each for Health, Wealth, Earth, Equality, and Trust. Then, calculate the Overall HIP Score for each company in your portfolio. Sustainability Faceoffs at FastCompany.com: "How HIP is Your...?”: Now that you understand the metrics that go into creating the HIP Score, you can begin to compare companies in your portfolio in what we like to call HIP Scorecard Face-Offs. Since this approach can be a lot to digest, face-offs help determine which company may be a better choice, and a higher weight in your diversified portfolio. FastCompany.com has featured some of HIP’s head-to-head company face-offs. It has added its own analysis and links to previous features it has written on the firms. See a mini-excerpt of the HIP face-off grids for companies and brands most of you already know. NOTE: Sustainability statistics are a mix of 2007, 2008, and 2009 data (since books quote historical information). Check each company’s website for the latest info. The HIP approach is intended as a tool to help you interpret the data. Retail: Sustainability Faceoff: Walmart vs. Target Energy: Sustainability Faceoff: Chevron vs. ExxonMobil Telecom: Sustainability Faceoff: Verizon vs. Sprint Beverages: Sustainability Faceoff: Coca-Cola vs. PepsiCo Franchise Food: Sustainability Faceoff: McDonald's vs. Starbucks Technology: Sustainability Faceoff: Microsoft vs. Apple Banking: Sustainability Faceoff: JP Morgan Chase vs. Bank of America Defense: Sustainability Faceoff: Raytheon vs. Lockheed Martin Personal Care Products: Sustainability Faceoff: Procter & Gamble vs. Colgate-Palmolive Industrial Materials: Sustainability Faceoff: Dow vs. DuPont In summary, an inclusive and diversified investment approach that uses specific metrics of evaluation like HIP Investor’s Health, Wealth, Earth, Equality and Trust, can not only fuel the race for more sustainable business practices and results, but has the potential to also be profitable. Combining findings on a company’s products, human impact, and management practices to determine a company’s HIP Score allows investors to truly know the company in an in-depth way. Finally, investors are able to compare and contrast their potential investments in order to see how best to construct a more HIP portfolio. In our next feature, we will describe a range of investment choices that build a more HIP portfolio across all asset classes, including cash, fixed income, equities and commodities. To navigate this series, please use this table of contents. *** HIP Investor supports Spring of Sustainability.  For three months, the Spring of Sustainability will feature 100 “stars” of sustainability, from Jane Goodall to Bill McKibben to Van Jones, in free interactive teleseminars throughout the spring of 2012. Live events will also be held in cities across the globe. *** R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois. NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com Follow on Twitter @HIPInvestor