How do sector-specific investors value their portfolios?

Did you know that if you focused solely on earnings, you are likely to value Toyota Motor Corporation higher than Tesla despite the fact that Tesla’s market capitalization is several times that of Toyota?

These inaccuracies originate from forcefully applying traditional valuation methods without any regard for the unique characteristics of the sectors of each company. Hence, instead of sticking to a one-size-fits-all method, you need a customized approach for each company in your portfolio.

To help you navigate this conundrum, this article will explore how sector-specific investors approach portfolio valuations, offering insights into tailored methods for different industries. Read on to know more!

Methods of portfolio valuation in different industries

Sector-specific investors often establish specialized valuation methodologies or base the valuation of their portfolio companies around certain key metrics to ensure that the limitations of traditional valuation methodologies do not lead them to overlook unique industry dynamics.

In the following sections, we will discuss the unique viewpoints of sector-specific investors, their methods of portfolio valuation, and some key metrics that they are likely to pay more attention to than generalists.

Financial services

Financial services companies can be easy to value because of the abundance of data and the nature of their business models. Often, a financial services company’s business model can directly translate into a valuation model. For instance, you could easily value the Bank of America by looking at the volume of its deposits, its net interest margin (NIM), and its reserve ratio.

However, as we venture into new frontiers such as crypto wallets, regulatory changes pose significant risks. Because of the nascent nature of these services, regulators are still exploring ways to ensure fair practices and hence, may change regulations from time to time.

Hence, investors focusing on financial services startups carefully discount the valuations for regulatory risks.

The abundance of financial data and comparable companies also allows investors to get accurate insights from the market approach. Interestingly, research has shown that analysts focus more on the price-to-book (P/B) ratio than on the price-to-earnings (P/E) ratio.

Let us look at how a portfolio of financial services companies can be valued using the P/B ratio.

As of 29th November 2024, the P/B ratio of Dow Jones US Financial Services was 2.56. Let us apply this ratio to the following portfolio.

Company	Book value	Valuation (2.56 X Book value)
MoneyScribe	$2,000,000	$5,120,000
Fincora	$5,000,000	$12,800,000
WealthPal	$4,000,000	$10,240,000
North Star Capital	$3,200,000	$8,192,000
Finedge	$3,550,000	$9,088,000

Real estate

We can meaningfully classify real estate companies based on how they utilize their portfolio. Real estate companies like Real Estate Investment Trusts (REITs) typically invest in commercial properties and aim to earn rental yield. The value of REITs and similar companies can be derived by taking the income-based approach to valuation.

Research shows that analysts prefer looking at cash flow metrics such as funds from operation (FFO) rather than at accrual earnings to value such companies. Hence, price-to-adjusted funds from operations (P/AFFO) is the most-used valuation multiple for such companies.

On the other hand, dealers and developers must be valued based on their real estate portfolio valuation. This requires extensive research into market trends, income trends, interest rates, and consumer preferences. Since their properties can also be used to yield a rental income, such companies can also be valued using income-based valuation multiples like price-to-rent (P/R) and gross rent multiplier (GRM).

Let us see how a portfolio of real estate companies can be valued using P/FFO.

Suppose the P/FFO for US real estate companies is 12. Now, let us apply this ratio to a real estate portfolio.

Company	FFO	Valuation (12 X FFO)
Cardinal Realty	$500,000	$6,000,000
Venzo Realty	$1,500,000	$18,000,000
LandLure	$600,000	$7,200,000
EstateCaster	$1,200,000	$14,400,000
PropHaven	$1,440,000	$17,280,000

Manufacturing

Estimating the cash flows for a manufacturing business is relatively straightforward compared to other companies since increasing production beyond a certain point requires significant capital expenditure.

Hence, the income-based valuation approach is often used to value manufacturing companies. Particularly, the discounted cash flow (DCF) method is used since it incorporates future cash flow projections and capital expenditures into the business valuation.

Another aspect to consider in manufacturing company valuation is the possibility of liquidation and acquisitions. We can derive the liquidation value through the asset-based approach and the acquisition value through the market-based approach. Finally, we can take a weighted average of the valuations from the three approaches based on the possibilities of continuing business, liquidation of business, and acquisition of business.

Let us use the discounted cash flow (DCF) method to value Mechatronia, a manufacturing company.

Their financial results for the current year are as follows. The table also contains financial performance expectations.

Particulars	Amount	Expectations
Net income	$8,000,000	Annual growth of 6%
(-) Interest	$1,200,000	To remain stable
(+) Non-operating gains or losses	$800,000	Non-repeating item
Income after interest and non-operating gains or losses	$7,600,000	-
(-) Tax	$1,596,000	21%
Non-operating profit after tax (NOPAT)	$6,004,000	-
(-) Investment	$2,000,000	Further investments of $4 million are required after 2 years
Free cash flow (FCF)	$4,004,000	-

Now, let us make financial projections for Mechatronia and discount the FCF by a discounting rate of 6%.

Particulars	2025	2026	2027	2028	2029
Net income	$8,480,000	$8,988,800	$9,528,128	$10,099,816	$10,705,805
(-) Interest	$1,200,000	$1,200,000	$1,200,000	$1,200,000	$1,200,000
(+) Non-operating gains or losses	$0	$0	$0	$0	$0
Income after interest and non-operating gains or losses	$7,280,000	$7,788,800	$8,328,128	$8,899,816	$9,505,805
(-) Tax	$1,528,800	$1,635,648	$1,748,907	$1,868,961	$1,996,219
Non-operating profit after tax (NOPAT)	$5,751,200	$6,153,152	$6,579,221	$7,030,854	$7,509,586
(-) Investment	$0	$4,000,000	$0	$0	$0
Free cash flow (FCF)	$5,751,200	$2,153,152	$6,579,221	$7,030,854	$7,509,586
Discounted cash flows (FCF)/(1+6%)^(Year of cash flow - Present year)	$5,425,660	$1,916,298	$5,524,041	$5,569,095	$5,611,599

We have limited the financial projections to 5 years since our expectations might not hold beyond this term.

Thus, based on the DCF method, Mechatronia would be worth $24,046,693 (total of discounted cash flows).

Technology

When you are valuing a tech company, it is extremely important to consider the scalability of the business as well as network effects. When a tech company gathers momentum, it can scale operations much faster than others because of lower marginal costs. Hence, investors often keep track of their tech companies’ progress towards critical mass after which point the valuations can skyrocket.

If a tech company earns revenue through a subscription-based model, in addition to customer acquisition metrics, investors also look at the percentage of retained subscribers to assess the risks to cash flows. Investors are also wary of startups that burn money to acquire customers. Hence, customer acquisition costs (CACs) are another metric that tech investors pay a lot of attention to.

You must note that a major challenge with valuing tech companies is how varied their business models can be. Hence, investors focusing on tech companies might avoid imposing metrics across the board and prefer tracking specific key metrics sometimes referred to as the North Star metric for each segment. For a software company valuation example, take a look at this article.

Healthcare

We can classify healthcare companies as innovators, manufacturers, and marketers. As the titles suggest, innovators make significant research and development (R&D) investments in hopes of developing new therapies, medical apparatus, and pharmaceuticals. Healthcare manufacturers produce pharmaceuticals and related products as contract manufacturers. Marketers are responsible for the distribution of healthcare products.

Due to the similarities in business models, valuation methodologies and metrics are similar for healthcare manufacturers and traditional manufacturing companies. Similarly, consumer goods companies and healthcare marketers are valued using similar principles.

When you are valuing healthcare innovators, it is important to assess their patent portfolio valuation while also estimating the net present value of future cash flows. These cash flows are either generated through licensing fees or in-house manufacturing and marketing of products. To value innovators who also act as manufacturers and marketers, a hybrid approach must be taken.

To understand how patents can be valued, take a look at this article.

Consumer Goods

We mainly rely on the income-based approach to value consumer goods companies unless they become acquisition targets or are likely to be liquidated in the near future. Such companies are characterized by high sales volumes and low margins. In this sector, you will observe a high degree of homogeneity of products. Hence, maximizing economies of scale and building strong brand loyalty is extremely important for such companies.

With such a business model, it is best not to over-complicate things and simply use the income-based approach.

Hence, consumer goods investment portfolio valuation centers around earnings metrics such as price-to-earnings (P/E) ratio, earnings yield, price-to-sales (P/S) ratio, enterprise value-to-revenue (EV/Revenue) ratio, and EV to earnings before interest, tax, depreciation, and amortization (EV/EBITDA).

To account for brand strength and economies of scale, consumer goods investors value their portfolio companies by benchmarking against industry peers and leaders through the comparable company analysis method.

Let us see how a portfolio of consumer goods companies can be valued using the P/E ratio.

As of 29th November 2024, the P/E ratio of Dow Jones US Consumer Goods Index was 27.45.

Company	Earnings	Valuation (Earnings X 27.45)
Touchstone Goods	$700,000	$19,215,000
DuoGoods	$1,300,000	$35,685,000
MavericksGoods	$1,000,000	$27,450,000
HomeSweet	$1,200,000	$32,940,000
FairGoods	$1,050,000	$28,822,500

Eqvista – Your Partner in Maximizing Portfolio Value!

When an investor specializes in a particular sector, they often utilize specialized portfolio valuation methods. If your portfolio companies are mainly from the financial services sector, you should pay attention to metrics like P/B ratio and P/E ratio while accounting for regulatory risks in emerging segments.

Real estate portfolio valuation involves estimating the market values of the portfolios held by developers and dealers while also estimating rental yields for companies that operate as landlords.Since manufacturing and consumer goods are traditional sectors, we typically use the income-based approach to value these companies, unless they face liquidation or become acquisition targets.

Because of varied business models in the tech sectors, instead of applying the same valuation metrics across the board, valuations are adjusted as per North Star metrics, progress toward critical mass, and scalability.

With healthcare innovator companies, we must pay special attention to patent portfolio valuations and assess expected cash flows from products in development. In contrast, healthcare marketers and manufacturers can be more accurately valued when looked at as consumer goods companies and manufacturing companies, respectively.

Whether you are building a sector-specific or sector-neutral portfolio, you can gain accurate insights for investment evaluation and decision-making by relying on Eqvista’s portfolio valuation services.

Contact us to know more!