How to Value a Stock Depending on the Domain

Picture this: You're at a car dealership, and the salesperson tries to sell you a sports car by bragging about its trunk space. Sounds ridiculous, right? Yet investors make this exact mistake every day when they use the wrong metrics to value different types of stocks.

Understanding stock valuation isn't about memorizing formulas—it's about knowing which questions to ask for each type of business. A metric that screams "bargain" in one industry might signal disaster in another.

Let's break down how to properly value stocks across different sectors, with real-world examples that make sense.

Why Industry-Specific Valuation Matters

Before we jump into the specifics, here's the fundamental truth: businesses make money in vastly different ways. A software company selling subscriptions operates nothing like a bank lending money or a retail store selling physical goods.

Think about it this way: When you evaluate a restaurant, you care about foot traffic, table turnover, and food costs. But if you're looking at a law firm, those metrics are useless. Instead, you'd focus on billable hours and client retention. The same logic applies to stocks.

Technology & High-Growth Companies: Betting on Tomorrow

The Landscape

Technology companies, especially younger ones, play by different rules. Many aren't profitable yet—and that's often intentional. They're pouring every dollar back into capturing market share before competitors do.

Take Salesforce in its early days. The company operated at a loss for years while building the dominant customer relationship management platform. Investors who focused solely on profitability missed out on a hundred-bagger.

What Actually Matters

Price-to-Sales Ratio: Your North Star

When a company isn't making profits, revenue becomes your main indicator. The P/S ratio tells you how much you're paying for each dollar of sales.

Example: Let's say Company A trades at $50 per share with annual revenue of $10 per share. That's a P/S ratio of 5. Company B trades at $30 with revenue of $3 per share—a P/S of 10. Which is the better value? It depends on growth rates.

Real-world case: In early 2020, Zoom Video Communications had a P/S ratio around 25, which seemed expensive. But the company was growing revenue at over 300% annually during the pandemic. That explosive growth justified the premium. Meanwhile, a legacy software company growing at 5% per year with a P/S of 10 would be overpriced.

Revenue Growth Rate: The Growth Story

This metric separates the winners from the pretenders. A company growing at 50% annually doubles in size every 1.4 years. One growing at 10% takes over seven years to double.

Real-world case: Look at Snowflake's IPO in 2020. Despite having a sky-high valuation, investors bet on its 174% revenue growth rate. The company was clearly winning market share in cloud data warehousing. Even though the stock was "expensive" by traditional measures, the growth trajectory told a compelling story.

The Rule of 40: The SaaS Health Check

This simple formula separates sustainable businesses from those burning cash recklessly: Growth Rate + Profit Margin should equal at least 40.

Example calculation:

✅ Company growing at 35% with a 10% profit margin: 35 + 10 = 45 (Healthy)
❌ Company growing at 60% with -25% margin: 60 + (-25) = 35 (Concerning)
✅ Company growing at 15% with 30% margin: 15 + 30 = 45 (Healthy)

Real-world case: Shopify maintained a Rule of 40 score above 40 throughout its growth phase, signaling it could grow fast while maintaining fiscal discipline.

Customer Economics: The Unit Economics Test

For subscription businesses, two numbers tell you if the business model actually works:

Customer Acquisition Cost (CAC): What you spend to get one customer
Lifetime Value (LTV): How much profit that customer generates over time

The golden rule: LTV should be at least 3x CAC.

Example: Suppose a streaming service spends $150 in marketing to acquire a subscriber (CAC = $150). That subscriber pays $15 monthly and stays for an average of 24 months, generating $360 in revenue. With a 50% gross margin, the LTV is $180. The ratio is only 1.2x—the business is unsustainable. They're spending too much to acquire customers who don't stick around long enough.

Real-world case: Contrast this with Netflix in its prime, where the LTV/CAC ratio exceeded 3x, funding its massive content library.

What to Watch Out For

High valuations are fine if growth justifies them, but watch for slowing growth rates. When a company valued at 20x sales sees growth decelerate from 40% to 15%, the stock often crashes. The market priced in continued acceleration that didn't materialize.

Financial Sector: Following the Money

The Unique Nature of Banks

Banks aren't like other businesses. They don't make widgets or sell services. They're fundamentally money managers—borrowing from depositors at low rates and lending to borrowers at higher rates, pocketing the spread.

This business model means traditional valuation metrics miss the mark entirely.

The Right Metrics for Financials

Price-to-Book Ratio: The Financial Sector Standard

Book value represents a company's net assets—what's left if you paid off all debts and liquidated everything. For banks, this matters immensely because their assets (loans) and liabilities (deposits) are the business.

A P/B ratio under 1.0 means the stock trades below its accounting value. This could signal a bargain or serious problems with asset quality.

Example: During the 2008 financial crisis, many banks traded at P/B ratios of 0.3 to 0.5. Citigroup hit 0.2x book value. Investors who believed the banks would survive made fortunes. Those who picked banks with toxic assets lost everything.

Real-world case: In normal times, a healthy regional bank might trade at 1.2-1.5x book value, while a premium institution like JPMorgan Chase trades at 1.8-2.0x book, reflecting superior management and asset quality.

Return on Equity: Efficiency Matters

ROE shows how effectively a bank turns shareholder equity into profit. Calculate it by dividing net income by shareholder equity.

Example: If Bank A has $1 billion in equity and generates $150 million in profit, the ROE is 15%. Bank B has the same equity but makes $100 million—an ROE of 10%. Bank A is using capital more efficiently.

Real-world case: Wells Fargo historically maintained an ROE above 12%, while smaller regional banks often struggled to hit 10%. That efficiency translated into higher valuations.

Dividend Yield: The Income Play

Many investors buy bank stocks for steady income. A 4% dividend yield means you receive $4 annually for every $100 invested.

Example: Bank of America stock trades at $30 and pays $0.90 annually in dividends. That's a 3% yield. If the bank consistently raises dividends annually—say from $0.84 to $0.90 to $0.96—it signals confidence in future profits and attracts income investors.

Red Flags in Banking

Watch out for banks trading well below book value combined with declining ROE. This often indicates bad loans hiding on the balance sheet. Also, a dividend yield above 7-8% typically signals the market doubts its sustainability.

Retail & Consumer Goods: The Efficiency Game

Why Retail Is Different

Retail operates on thin margins. Whether you're running Walmart or a boutique clothing store, you buy inventory, mark it up slightly, and hope to sell it before trends change or products spoil.

Success comes down to operational excellence—turning inventory quickly, managing real estate efficiently, and building brands customers trust.

Retail Valuation Metrics

Price-to-Earnings Ratio: Back to Basics

For mature retailers with stable profits, P/E ratio works beautifully. It tells you how many years of earnings you're paying for.

Example: Target trades at $150 with annual earnings of $10 per share. That's a P/E of 15. Walmart trades at $160 with earnings of $6.40—a P/E of 25. On the surface, Target looks cheaper, but you need context about growth rates and competitive positioning.

Real-world case: Dollar stores like Dollar General often trade at P/E ratios of 20-25 because they're still expanding to new markets. Meanwhile, legacy department stores might trade at P/E ratios of 8-10, reflecting declining traffic and uncertain futures.

Same-Store Sales Growth: The Real Growth Story

Any retailer can boost revenue by opening new stores. But can existing stores grow sales? That's what same-store sales (also called comparable store sales or "comps") measure.

Example: Chipotle reports total revenue grew 15%, but 8% came from new store openings and 7% from same-store sales. That 7% same-store growth is the key number—it shows the brand is getting stronger, not just bigger.

Warning sign: Negative comps are a huge red flag. When Gap reported same-store sales declining 5% year after year, it signaled customers were abandoning the brand, even as the company opened new locations internationally.

Inventory Turnover: Cash Flow Reality

This metric reveals how many times per year a company sells and replaces its inventory. Calculate it by dividing cost of goods sold by average inventory.

Example: Let's say Retailer A has $100 million in inventory and $800 million in cost of goods sold. Turnover is 8x annually—they cycle through inventory every 1.5 months. Retailer B with the same inventory but only $400 million in sales turns inventory just 4x yearly—every 3 months.

Retailer A is healthier. Faster turnover means less capital tied up in merchandise, lower storage costs, and fresher products.

Real-world case: Costco is the king of inventory turnover, hitting 12-13x annually. They sell products almost as soon as they arrive. Fashion retailers like Zara achieve similar speeds, while struggling retailers like Bed Bath & Beyond saw turnover rates collapse below 3x before bankruptcy.

Gross Margin: Pricing Power Indicator

Gross margin shows what percentage of revenue remains after paying for the products sold. It's your markup.

Example: If you buy a shirt for $10 and sell it for $20, your gross margin is 50%. The higher the margin, the more pricing power and brand value you have.

Real-world cases:

Apple maintains gross margins near 40% on iPhones—astronomical in consumer electronics. This pricing power reflects brand strength.
Generic Android manufacturers operate at 10-15% margins, competing mainly on price.
Whole Foods commanded 35% gross margins before Amazon's acquisition, while traditional supermarkets ran at 25-28%. That premium reflected customers paying more for the experience and product quality.

** Key Takeaway:** In retail, operational efficiency and brand strength determine success. Rising margins and positive comps signal a healthy, growing business.

🏢 Real Estate Investment Trusts: Cash Is King

Why REITs Require Special Treatment

REITs own apartments, office buildings, shopping centers, and other income-producing properties. They're required by law to distribute 90% of taxable income as dividends, making them income vehicles.

The catch: Real estate accounting includes massive depreciation expenses that don't reflect economic reality. A building might "depreciate" on paper while appreciating in actual value.

REIT-Specific Metrics

Funds From Operations: The True Cash Flow

FFO adds back depreciation and amortization to net income, revealing actual cash generated by properties.

Example calculation:

Net Income:        $50 million
+ Depreciation:    $30 million
+ Amortization:    $5 million
= FFO:             $85 million

That $85 million represents real money available for dividends and growth. The $50 million net income figure is artificially depressed by non-cash charges.

Real-world case: Realty Income, known as "The Monthly Dividend Company," consistently reports FFO significantly higher than net income, funding its reliable monthly payments to shareholders.

Adjusted FFO: The Maintenance Reality

AFFO goes one step further by subtracting routine capital expenditures—the money needed to maintain properties.

Example: Your apartment REIT might report FFO of $100 million, but if it spends $20 million annually replacing roofs, updating units, and repaving parking lots, the AFFO is $80 million. That's the cash truly available for dividends and expansion.

** Important:** Smart REIT investors compare the dividend payout to AFFO, not FFO. If the payout ratio exceeds 90% of AFFO, the dividend may be unsustainable.

Net Asset Value: What's It Really Worth?

NAV estimates the current market value of all properties owned, minus debt. It's like appraising your house.

Example: If a REIT trades at $20 per share but its NAV is estimated at $25, the stock trades at a 20% discount to the underlying real estate value—potentially a buying opportunity.

Real-world case: During market panics, REITs often trade at 30-40% discounts to NAV as investors flee. Buyers who recognized this discount in March 2020 doubled their money within 18 months as valuations normalized.

Watch These Warning Signs

REITs funded by debt need scrutiny. If a REIT shows rising leverage (debt-to-assets ratio climbing above 50%) and declining occupancy rates, trouble looms. Also, watch for REITs cutting dividends—it signals serious cash flow problems since they're required to distribute most earnings.

Utilities & Energy: The Steady Eddies

The Nature of Infrastructure Businesses

Utilities and energy companies operate massive, expensive infrastructure—power plants, pipelines, transmission lines. They're often regulated monopolies with predictable cash flows and limited growth.

Investors treat them like bonds with equity upside, focusing on income and stability over growth.

Infrastructure Valuation Tools

EV/EBITDA: Accounting for Debt

Enterprise Value (market cap plus debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, amortization) gives a complete picture when debt is significant.

Comparison example:

Company A:

Market cap: $10 billion
Debt: $8 billion
Cash: $1 billion
Enterprise Value: $17 billion
EBITDA: $2.5 billion
EV/EBITDA: 6.8x

Company B:

Market cap: $12 billion
Debt: $2 billion
Cash: $1 billion
Enterprise Value: $13 billion
EBITDA: $2 billion
EV/EBITDA: 6.5x

Despite Company A's smaller market cap, Company B is actually cheaper once you account for debt levels.

Real-world case: NextEra Energy, one of the largest clean energy companies, typically trades at EV/EBITDA multiples of 14-16x, reflecting its growth in renewables. Traditional utilities trade at 8-10x, reflecting slower growth prospects.

Dividend Payout Ratio: Sustainability Check

This ratio shows what percentage of earnings is paid as dividends. Calculate it by dividing annual dividends by earnings per share.

Example: If a utility earns $3 per share and pays $2 in dividends, the payout ratio is 67%. This leaves room for dividend growth and unexpected expenses.

Warning signs:

A payout ratio above 90% raises concerns—there's little cushion if earnings dip
Some utilities even pay out more than 100% of earnings temporarily, which is unsustainable

Real-world case: Southern Company maintains payout ratios around 70-75%, balancing generous dividends with financial flexibility. When you see a utility with a 5% dividend yield and a 95% payout ratio, that dividend is at risk.

Free Cash Flow: The Reality Check

Free cash flow equals operating cash flow minus capital expenditures. For capital-intensive businesses, this matters enormously.

Example: A pipeline company might show $500 million in operating cash flow, but if it must spend $400 million annually maintaining pipelines, free cash flow is only $100 million. That's what's available for dividends, debt reduction, and growth projects.

Real-world case: Kinder Morgan, one of North America's largest pipeline operators, focuses heavily on free cash flow to cover its dividend. When energy prices collapsed in 2015-2016, many energy companies couldn't generate enough free cash flow to maintain dividends. Those who stressed FCF in their analysis avoided the carnage.

Danger Zones in Utilities

Watch for utilities in regions with hostile regulators—they may struggle to raise rates enough to cover costs. Also, traditional utilities facing competition from renewable energy may see stranded assets (investments that become worthless) if coal plants must close prematurely.

Putting It All Together: A Sector-by-Sector Cheat Sheet

Tech/High-Growth:

Focus: Future potential
Key metrics: P/S ratio, revenue growth, Rule of 40
Example: Would you rather own a company at 10x sales growing 50% or 5x sales growing 10%? Often the first.

Financials:

Focus: Asset quality and efficiency
Key metrics: P/B ratio, ROE, dividend yield
Example: A bank at 1.2x book with 14% ROE beats one at 0.8x book with 6% ROE.

Retail:

Focus: Operational efficiency
Key metrics: P/E ratio, same-store sales, inventory turnover
Example: Rising comps and improving margins signal pricing power and healthy demand.

REITs:

Focus: Cash generation
Key metrics: FFO, AFFO, NAV
Example: A REIT trading at 0.8x NAV with 5% AFFO yield could be significantly undervalued.

Utilities/Energy:

Focus: Stability and income
Key metrics: EV/EBITDA, dividend payout ratio, FCF
Example: A 4% dividend with 70% payout ratio and strong FCF is far safer than 6% with 95% payout.

Final Thoughts: Context Is Everything

The biggest mistake investors make isn't using wrong formulas—it's applying right formulas to wrong situations. A low P/E ratio isn't automatically good, and a high P/S ratio isn't automatically bad. Context matters.

Before you analyze any stock, ask yourself: What business is this company really in? How do successful companies in this industry make money? What would cause this business model to break?

Answer those questions first, then choose your metrics accordingly. You wouldn't judge a fish by its ability to climb a tree. Don't judge a software company by banking metrics or a utility by tech company standards.

Master the art of using the right yardstick for each situation, and you'll make far better investment decisions than the crowd still using one-size-fits-all approaches.

Remember: This guide is for educational purposes only. Every investment carries risk, and you should conduct thorough research or consult with a financial professional before making investment decisions. Past performance never guarantees future results.