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Profits and diversity: five charts demonstrating the link

Axa Investment Management argues diversity creates higher profits.

Businesses often express moral support for greater inclusion but there may also be an argument on self-interest grounds.

Axa Investment Management says the data suggests a direct causal link between diversity and increased profits.

AXA director of earnings forecast models Srilatha Singh and head of sustainable investing Kathryn Macdonald said: ‘Putting aside the question of morality, we find evidence that diversity is “economically correct” in that it is associated with positive economic outcomes for companies.

‘For those of us committed to diversity in the workplace, these results support the idea that diversity is not just a “nice to have”; we believe it is instead a “must have” in the face of intense market competition.’

 

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Businesses often express moral support for greater inclusion but there may also be an argument on self-interest grounds.

Axa Investment Management says the data suggests a direct causal link between diversity and increased profits.

AXA director of earnings forecast models Srilatha Singh and head of sustainable investing Kathryn Macdonald said: ‘Putting aside the question of morality, we find evidence that diversity is “economically correct” in that it is associated with positive economic outcomes for companies.

‘For those of us committed to diversity in the workplace, these results support the idea that diversity is not just a “nice to have”; we believe it is instead a “must have” in the face of intense market competition.’

 

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Profitability of higher/lower diversity companies

January 2005 – July 2017

On average, based on the historical data, diverse companies are simply more profitable than their less diverse peers.

Importantly, the variability of the profitability is less for
more diverse companies.

The profitability advantage of more diverse firms is consistent over time, becoming especially pronounced during the period 2009 – 2011 when the US market’s aggregate profitability dramatically dipped.

 

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Forward one year profitability of high/low diversity companies

January 2005 – July 2017

While companies with diverse boards have a distinctive profitability advantage at any point in time, we wondered if the more diverse companies of today go on to enjoy a profitability advantage in the future.

We tested this by looking at the relationship between a company’s diversity level at a point in time (‘today’) and profitability the subsequent year (‘tomorrow’) for our groups of more and less diverse companies. 

We observe that companies that are more diverse ‘today’ go on to have higher profitability "tomorrow", compared to their less diverse peers and the market generally.

The future profitability is less variable for the higher diversity group compared to less diverse companies, but not lower than the market as a whole.

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Mean reversion pressures on profitability

January 2005 – July 2017

To answer the question of "moat" directly, we look at the impact of diversity on future profitability for the most profitable stocks at a point in time.

We start by showing current and one-year-forward return on equity [ROE] for the market as a whole and then by ROEX [return on equity net extraordinary items] quartiles.

The final set of bars illustrates the downward, mean-reversion pressure on the most profitable group of companies, the top ROEX quartile.

It is very difficult for companies in this category to maintain their ‘top’ position in the face of competitive pressures like competitors offering similar products, other companies hiring away their best people, and pricing competition.

This known drop in future profitability among the companies in the top ROEX quartile is the reason we are interested in company features that might act as a ‘moat’ to protect against mean reversion.

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Top ROEX quartile partitioned by diversity

January 2005 – July 2017

We find evidence that diversity on the board can create such a ‘moat’.

We partitioned the top ROEX quartile into higher and lower diversity groups.

Within this most profitable part of the market, the higher diversity stocks appeared significantly more resilient in the face of competitive pressures.

While their forward profitability is still lower, the more diverse companies simply lost less than their peers during the timeframe shown.

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Top quartile ROEX average 3-year forward sales volatility by diversity segment

January 2005 – July 2017

We believe that more diverse firms most likely have advantages
when it comes to discouraging new entrants, discouraging brand/
product substitution, and innovation.

[A] way we might observe the impact of better innovation,
better brand loyalty, or lack of perceived substitutes is to look at the
volatility of firm-wide sales for high and lower diversity firms, within the highest profitability quartile.

Our hypothesis is that more diverse firms would experience lower volatility of sales.

What we see is that within the most profitable end of the equity spectrum, it is indeed the case that more diverse firms saw greater sales stability.

 

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