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Environmentally-friendly investments are becoming increasingly popular as more investors look to make their money work for causes they care about. Investing in green stocks, or stocks of companies that prioritize environmental sustainability, is a key component of socially responsible investing, which is a subset of the ESG (environmental, social and governance) movement .

Here’s what you need to know about investing in green stocks and why it’s important to do your research.

What are green stocks?

Green stocks, sometimes called green chip stocks, can be attractive to investors who prioritize certain values, including environmental sustainability. These stocks are associated with companies engaged in environmentally friendly practices or products. For example, green stocks can be associated with companies that construct solar panels or wind farms.

Green stocks are generally associated with companies engaged in practices such as alternative and renewable energy, recycling and waste reduction, water and aquaculture, pollution control, green transportation and organic agriculture. That said, the category of green stocks is not an official designation, and can generally encompass a wide range of green-friendly companies. Closely related is environmental, social and governance (ESG) investing, a broader category that looks at more than just a company’s environmental impact.

What is socially responsible investing?

Socially responsible investing (SRI), a subset of ESG investing, refers to an investment strategy that prioritizes making a positive impact on society, while generating financial returns. Investors who use this approach seek out companies that embody a community-focused approach to running their businesses.

In addition to green stocks, socially responsible investors may also look to invest in companies that adopt fair labor practices, avoid controversial weapons manufacturers and meet other ethical standards, which puts them in the broader ESG umbrella. The standards may extend to so-called “sin stocks,” such as alcohol and tobacco firms.

How do green stocks perform?

Many green stocks have performed well in the last decade, as increasing environmental awareness and investment have helped these companies grow their revenue. However, it’s hard to generalize for such a wide field of companies across many industries. The factors that affect solar energies companies aren’t the same ones facing makers of electric vehicles, for example.

However, the increasing cost of “old economy” inputs such as fossil fuels is making it more difficult for companies invested in these technologies. Meanwhile, newer companies without these legacy investments and with more efficient products may be winning over consumers. And if the level of risk is rising, investors may be pricing that into the stocks of old-line companies.

How to invest in green stocks

Your first step as a prospective investor in green stocks is to look for companies within those industries and practices. Investing in green technology can be done by purchasing stocks from companies that prioritize environmentally friendly technologies. If you’re looking for individual stocks, you can run a stock screen for companies in green industries such as renewable or alternative energies or waste recycling.

Alternatively, you can choose to invest in mutual funds or index funds that represent the larger environmental market. These funds allow investors to profit on the success of the industry without having to analyze individual stocks. With ESG funds, you’ll own many different companies that are riding the wave of green technology, as well as other socially-inclined and governance-oriented initiatives.

Risks of investing in green stocks

Investing in certain green stocks can be risky due to the developmental stage of many companies in the field. Often, these green companies in the development phase may not have substantial revenue and may have high earnings valuations. If you’re investing in individual stocks, you’ll need to understand this issue as well as the value of a company’s products, its competitive positioning, its financial position and more. If the company is not a success, your investment could become worthless.

Additionally, the definition of “green” can vary. Some companies with high ESG ratings engage in dubious environmental practices and may produce technology that relies on mining or other unsustainable practices. Before investing, investors should research companies and examine prospectuses and annual filings. This research will help investors ensure that the company aligns with their own definition of green.

Ultimately, there’s nothing magical about the company producing or using green technology. Over time, the company will have to deliver a profit, or at least break even, regardless of how good environmentally-oriented it is. So, you need to analyze the business prospects of potential investments and refrain from getting wrapped up in emotion when selecting green stocks.

Bottom line

Green stocks are an attractive option for investors who seek to reap financial returns, while also contributing to society. However, many “green” companies are in developmental stages, which can mean investment entails elevated risk. This requires careful research and understanding of the sector.