Sector Differences in Valuation
A P/E of 25 can be cheap, fair, or expensive—it all depends on the sector. Let's explore why.
Why Sectors Have Different Valuations
1. Growth Rates Differ
- Tech: 15-25% annual growth → Higher P/E justified
- Utilities: 2-5% annual growth → Lower P/E expected
2. Margins Differ
- Software: 70-80% gross margins → Higher P/S acceptable
- Grocery: 2-3% net margins → Lower P/S expected
3. Asset Intensity Differs
- Banks: Business IS the balance sheet → P/B matters most
- Consulting: Few assets, all human capital → P/B irrelevant
4. Risk Profiles Differ
- Utilities: Stable, regulated → Lower risk premium
- Biotech: Binary outcomes → Higher risk premium
Real Estate Analogy
Would you pay the same price per square foot for:
- A Manhattan penthouse?
- A rural farmhouse?
- A suburban office building?
Of course not! Location (sector) determines what's "normal."
Same with stocks—sector context determines what valuations make sense.
Sector Valuation Benchmarks
Technology
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 25-40 | High growth expectations |
| P/S | 5-15 | High margins justify premium |
| P/B | 5-20 | Intangibles dominate |
Key driver: Growth rate and margin expansion potential
Financials
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 10-15 | Mature, regulated |
| P/B | 0.8-1.5 | Book value is key |
| P/S | 2-4 | Less relevant |
Key driver: Book value and return on equity
Healthcare
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 15-30 | Wide range by sub-sector |
| P/S | 3-8 | Depends on profitability |
| P/B | 3-8 | R&D not fully captured |
Key driver: Pipeline value and patent protection
Consumer Staples
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 18-25 | Defensive premium |
| P/S | 1-3 | Lower margins |
| P/B | 4-10 | Brand value matters |
Key driver: Dividend yield and stability
Energy
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 8-15 | Cyclical, volatile |
| P/B | 1-2 | Asset-heavy |
| P/S | 0.5-2 | Commodity pricing |
Key driver: Oil/gas prices and reserves
Utilities
| Metric | Typical Range | Notes |
|---|---|---|
| P/E | 15-20 | Stable, regulated |
| P/B | 1.5-2.5 | Asset-based |
| Dividend Yield | 3-5% | Income focus |
Key driver: Dividend yield and regulatory environment
Key Takeaways
- Each sector has its own "normal" valuation range
- Growth sectors command higher multiples
- Asset-heavy sectors focus on P/B
- Always compare within the same sector
The Danger of Cross-Sector Comparison
Wrong approach: "Bank XYZ has P/E of 10, Tech ABC has P/E of 30. Bank XYZ is cheaper!"
Right approach: "Bank XYZ has P/E of 10 vs. banking sector average of 12. It's slightly cheap for a bank." "Tech ABC has P/E of 30 vs. tech sector average of 35. It's slightly cheap for tech."
ShareValue.ai Handles This
Our Valuation Score automatically adjusts for sector norms. A score of 70 means "cheap for THIS sector"—whether it's tech, banking, or utilities.
Sub-Sector Nuances
Even within sectors, there are differences:
Within Technology:
- Enterprise Software: P/S 8-15 (recurring revenue)
- Hardware: P/S 2-5 (lower margins)
- Semiconductors: P/E 15-25 (cyclical)
Within Healthcare:
- Pharma: P/E 12-20 (patent cliffs)
- Biotech: P/S 5-20 (often unprofitable)
- Medical Devices: P/E 20-35 (steady growth)
Within Financials:
- Big Banks: P/B 0.8-1.2
- Regional Banks: P/B 1.0-1.5
- Asset Managers: P/E 12-18
Sector Rotation and Valuation
Sector valuations aren't static. They expand and contract based on:
- Economic cycle — Cyclicals cheap in recession, expensive in expansion
- Interest rates — Utilities/REITs sensitive to rates
- Market sentiment — Growth vs. value rotations
- Sector-specific news — Regulations, innovations, disruptions
Sector Comparison Mistakes
- Comparing tech P/E to bank P/E
- Assuming low P/E always means cheap
- Ignoring sub-sector differences
- Not adjusting for current cycle position
Practical Application
When evaluating a stock:
- Identify the sector — What industry is this?
- Know the norms — What's typical for this sector?
- Compare to peers — How does it rank within sector?
- Consider the cycle — Is the sector cheap/expensive overall?
- Use ShareValue.ai — Our scores do this automatically
Congratulations! You've completed Module 5: Valuation Score Explained. You now understand how to evaluate whether a stock is cheap or expensive.
Next Module: Quality Score Explained—understanding what makes a business truly good.