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Is now the time to buy green shares?

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In the past several years, green shares have become a popular investing idea. Between a surge in environmental, social, and governance (ESG)-themed investing funds seeking a home and increased regulatory moves intending to help the environment, green shares have been in the spotlight like never before.

Is now a good time to buy green shares for my portfolio – or have I already missed the boat?

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Green shares have surged

Many shares with environmental credentials have surged over the past year or two. Consider as an example the waste management and recycling company Renewi. Its shares are up 219% over the past year, as of earlier today. Rival Biffa has put on 81% in the same period.

That sort of performance is typically associated with fast-growing companies. But Renewi’s revenues have fallen for the past two years in a row. While its profit performance has been improving, last year its £1.7bn revenue generated just £11m in post-tax profit. That’s a profit margin of less than 1%.

Biffa’s revenues last year also slid. It recorded a £41m loss. Both the chief executive office and finance chief sold shares on the open market last month.

Making money from green strategies

As an investor, I am interested first and foremost in the prospective financial returns from a share I might buy. But when I look at the accounts of companies like Renewi and Biffa, I am not encouraged. So I don’t think now is the time for me to buy such green shares.

Their profitability tends to move around quite a bit. Consistent revenue growth is also lacking. Profit margins look thin to me. Most of all, a lot of demand is driven not by pure market forces, but by specific political agendas. For example, local authorities contract such companies because they want to achieve certain defined environmental goals. On the one hand, that can be a lucrative source of revenue. But seen in another light, it means a company’s competitive advantage is fragile. A change in political priorities or environmental policy could cut off future demand even if a company’s service is good.

Green shares and financial fundamentals

The same can apply to green shares in other fields, from power generation to carbon capture. Straightforward commercial considerations are blurred by the prospect of government subsidies, bans on competitive products for the same task and a torrent of venture capital money pouring into environmental themes. Some of those companies may go on to be highly profitable and rewarding for shareholders. But in many cases, it is difficult to assess the long-term financial prospects for a green company amid changing environmental priorities.

Take Ceres Power or ITM Power as an example. I expect energy demand overall to grow with time. There is a concerted push in some countries to use less fossil fuels. But who will win from this? Ceres and ITM both have interesting technology – but both are loss-making. The longer that continues, the less compelling I find their investment cases to be.

I think many green shares have seen price rises ahead of the improvement in business prospects. I remain open to investing in green shares for my portfolio. But before I buy I’d focus on a share’s prospective financial returns based on its business fundamentals, not just its environmental story.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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