Social Risk & Share Price - a case study of Dicks Sporting Goods
How does a company lose $150M... But improve its share-price by 22%... Within the same 12 month period?
Following the school shooting in Parkland, Florida (February 2018), mid-cap US retailer Dicks Sporting Goods (DKS) announced it would restrict gun sales across stores nationally. Specifically, DKS would discontinue the sale of assault-style firearms, ban high-capacity magazines, and impose an age limit of 21 years on all gun sales. The restrictions were widely denounced by the National Rifle Association and other pro-gun groups, while the company suffered an estimated $150M revenue loss (directly associated with diminished firearm sales) over the 12 month period that followed.
Over that same timeframe, DKS share-price rose 22% from $32.02 (28 Feb 2018) to $39.06 (28 Feb 2019). When analysed, this seemingly unlikely scenario powerfully showcases the dawning and growing importance of the 'S' in ESG.
"Governance at a corporate level includes the processes through which a company’s objectives are set and pursued in the context of the social, regulatory and market environment."¹
Social & Societal Risk Factors
Investment is a forward looking activity. As a consequence, investor interests often extend well beyond quarterly and annual horizons in order to ascertain which companies are poised for long-term advantage. For a retail company, the pursuit of competitive edge must mirror the evolution of consumer sentiment.
In restricting gun sales, DKS anticipated that its commercial proximity to gun-related 'social harm' could have strategic implications for the firm's reputation with consumers over the medium to long-term (even if not immediately apparent given the contemporaneous attitude of the NRA). The bet, was that consumer sentiment would make it increasingly difficult for retailers to dissociate themselves from grave misuse of their products. In the specific case of Dicks Sporting Goods, the commercial assumption was that any continued sale of assault-style firearms would risk tainting the firm with the growing stigma of gun violence.
The rally in DKS share-price signals two things. First, it signals a vote of confidence by investors in the strategic judgement of the company board. Secondly however, it affirms that non-financial indicators such as 'social conscience' matter as a category and can be material to a firm's market valuation.
Widening the Investment Universe
DKS also correctly anticipated that by restricting gun sales, the firm would lift back the veil of negative screening historically imposed by ethically-minded investors. This would open up the company to an infusion of new capital from a wider universe of investors, helping improve its overall valuation. The mechanics of this are not complicated - by increasing the number of potential investors bidding (read 'demand') for a fixed supply of DKS shares, the laws of economics dictate that all else being equal, the price must rise until a new equilibrium is found.
A Tale of Two Markets
What emerges from this story, is that social and societal factors play an influential role across two markets. On the one hand the evolving social sensibilities of the consumer-base dictate the parameters within which retail firms may seek and secure competitive advantage. On the other hand, the social preferences of investors themselves can also serve as a source of value. If a firm is able to attract capital from a wider array of investors than its peers, it stands to benefit financially.
From the perspective of ESG investing, the case of Dicks Sporting Goods exemplifies an important (if counter-intuitive) reality. Non-financial indicators are not only material to a firm's valuation, but may in exceptional circumstances outweigh the impact of real financial loss. The consequences of this for how investors evaluate and weigh the contribution of social risk factors should not go understated.
This does not mean that financial underperformance should be treated flippantly. But where financial loss is incurred as a result of strategic repositioning in order to align with deep social factors, it may be rewarded by investors, especially where they are operating over a long-term horizon.
FOOTNOTES AND LINKS
¹ See Guidance from the ICSA The Chartered Governance Institute (accessible at: https://www.icsa.org.uk/about-us/policy/what-is-corporate-governance#:~:text=Corporate%20governance%20is%20the%20system,accountability%2C%20and%20who%20makes%20decisions)