4 Valuation Tips When Investing in Green IPOs

Eco-friendly investing is a prominent trend that is simultaneously changing the future of environment and financial industry. It is gaining popularity at a surprising pace. According to the World Economic Forum, green investing among OECD member nations is growing at a rate of 27% a year, as of 2013. Among non-OECD nations, the growth rate was almost twice as high – 47% a year!

Unfortunately, the state of green investing was a bit of a bubble. Some investors were choosing companies, solely because they are green. This led to problems in the future, because they were artificially inflating companies that may be doomed to fail. Fortune’s Erin Griffith wrote about the green tech bubble of 2008.

Investors have been forced to be more diligent about choosing green equities, debts and derivatives. Unfortunately, there are still some bad green investments out there, just like with any other type of investment. The trick is to do a careful valuation to choose the right green investments to choose investments that are going to perform well.

Here are some valuation tips that every green investor should take into consideration.

1.      Ignore Personal Emotions About Specific Green Companies

It is tempting to rally behind a company with a vision that you agree with. It is also easy to want to invest in a company with a team of leaders that have charismatic personalities.

You need to check these biases before pulling out your wallet. Being a socially conscious investor is a good thing. But you are still investing. Neither your future net worth or the world as a whole will benefit if you put your hard-earned money behind a green company that is destined to fail, no matter how noble the mission is. You must look for companies that have strong financial potential, as well as a mission you believe in.

2.      Be Careful With Overvalued Investments

Some investments are very objectively overvalued. You need to think twice before investing in them.

If a company has a very limited track record, you don’t want to pay $15 or more for a share of stock in it, especially during an IPO. It is probably not being properly valued and you are likely overpaying. It makes more sense to buy penny stocks in these green companies, because you are clearly taking a chance on any equity that doesn’t have a stable track record. You can afford to pay a higher market price for firms that have been in business for a couple of years and have a solid history of generating revenue.

3.      Look at the Return on Equity

Warren Buffett, the founder of Berkshire Hathaway and one of the three wealthiest men in the world, has long talked about the importance of investing in companies with strong returns on equity. These are companies that know how to make the most out of every dollar that is invested in them. This is the most important financial metric, according to Buffett.

“Focus on return on equity, not earnings per share.”

4.      Be Careful With Companies With High Debt Ratios

Green companies with high debt ratios need to be evaluated carefully. Here are the ratios to look at:

• Debt to assets
• Debt to income
• Debt to equity

Green companies tend to have higher debt ratios than the S&P 500 market average, because they are usually newer and have higher startup costs. However, this doesn’t mean that you should excuse companies with high debt ratios. If the ratio is higher than similar companies at the level of maturity, then you may need to think twice before investing.