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Module 3: Sector thinking

A bakery, a bank and a car maker all sell something, but they earn money in very different ways. So one ratio cannot judge all of them. This module shows what to look at in each sector.

How it connects. Module 1 · Financial statements taught you to read the three statements. Module 2 · Valuation taught you ratios such as P/E and EV/EBITDA. Here you learn which ratio fits which sector. All numbers below are made-up examples.

1. Why sectors matter

The everyday idea. You measure cloth in metres and milk in litres. Using the wrong unit gives nonsense. Shares work the same way. A sector is a group of companies doing similar business, such as banks or IT.

Simple rule. First ask: “How does this company earn money?” Then pick the yardstick. And compare a company with others in its own sector, not with a different sector.

Common trap. Saying “this bank has a low P/E and that IT company has a high P/E, so the bank is cheaper.” Different businesses deserve different P/Es.

2. Banks

The everyday idea. A bank takes money from savers (deposits) and lends it to others. It pays savers a low rate and charges borrowers a higher one. The gap is its earning.

Words you will meet.

• NIM (net interest margin): the gap, as a % of the money the bank lends out. Here about 4%.
• NPA (non-performing asset): a loan where the borrower has stopped paying. Under RBI rules a loan is usually an NPA after 90 days of missed payment.
• CASA: money in current and savings accounts. It costs the bank little interest, so a higher CASA share is good.
• P/B (price to book): share price divided by the bank’s net worth per share.
• ROE (return on equity): yearly profit divided by net worth. It shows how well owners’ money is used.

Why not EV/EBITDA? For a bank, deposits are the raw material it works with, not ordinary debt. So EV/EBITDA does not make sense. Use P/B together with ROE.

Worked example. Bank A: net worth ₹100, profit ₹15, so ROE = 15%. Bank B: net worth ₹100, profit ₹8, so ROE = 8%. If both trade at P/B 2, Bank A is the better value, because it earns more on the same net worth.

Common trap. A bank with a very low P/B looks cheap. It may be low because many of its loans have gone bad. Always check NPAs.

3. IT services

The everyday idea. An IT company sells its people’s time. Clients, mostly in the US and Europe, pay in dollars. Salaries are mostly paid in rupees.

Worked example. Costs are ₹6,500. At ₹85 per dollar, the profit is 8,500 − 6,500 = ₹2,000. At ₹80 it is 8,000 − 6,500 = ₹1,500. A weaker rupee lifts profit with no extra work.

What to check.

• Growth in dollars, not only in rupees, to remove the currency effect.
• Attrition: the % of employees leaving in a year. High attrition raises hiring and training costs.
• Order book or deal wins: work already signed, which shows future sales.
• Operating margin and P/E (IT has little debt, so P/E works well).

Common trap. Celebrating a profit jump that came only from a weak rupee. If clients in the US or Europe cut spending, sales can slow quickly.

4. FMCG

The everyday idea. FMCG means fast-moving consumer goods: soap, biscuits, tea, toothpaste. People buy them every week in good times and bad. So sales are steady.

What to check.

• Volume growth: how many more units were sold, apart from price changes. It shows real demand.
• Rural demand: a large part of buyers live in villages, so rural spending matters.
• Raw material costs such as palm oil and packaging, which push margins up or down.

Steady, so a high P/E. Investors pay more for steady profits, so FMCG often trades at a high P/E. That is normal for the sector, but it leaves little room for disappointment.

Common trap. Sales up 8% looks good. If 6% of it is only price hikes, fewer people may be buying.

5. Auto

The everyday idea. Buying a car can wait. In good times people buy; in tough times they delay. So auto sales and profits move in waves, called a cycle.

What to check.

• Monthly sales numbers. Auto companies publish them at the start of each month, so you can track demand.
• Input costs such as steel and aluminium.
• The shift to electric vehicles (EVs): who is ready, and how much it costs to change.
• EV/EBITDA usually suits auto better than P/E, because the business is heavy on factories and often has loans.

Common trap. At the top of the cycle, profits are at their highest, so the P/E looks lowest. It feels cheap exactly when profits may be about to fall. Look at several years, not just the latest.

6. Pharma

The everyday idea. Pharma companies make medicines. Many Indian ones make generics: copies of a medicine whose patent has ended, sold at a lower price. They sell at home and abroad, especially to the US.

What to check.

• US share of sales and the US FDA (the American drug regulator). The FDA inspects plants. A serious warning can stop supply from a plant.
• R&D spending as a % of sales. It is the cost of developing new medicines. More is not always better; ask what it has produced.
• Price control in India. The government caps prices of medicines on the essential medicines list.

Common trap. Looking only at profit and missing that one plant gives a big part of US sales. Check the annual report for such dependence.

7. Putting it together

Use this four-step routine on any company:

1. How does it earn? Say it in one line.
2. Pick the yardstick that fits (table below).
3. Compare with companies in the same sector, not with other sectors.
4. Check the sector’s trap. Then go back to Module 1 · Financial statements and test whether profit turns into cash.

A ratio tells you where to look, not what to buy. Takeaway: first understand the business, then choose the yardstick.

Disclaimer: WealthyTrees is for education only. Nothing here is investment advice or a recommendation to buy, sell or hold any share or product. Numbers and examples are made up. WealthyTrees is not a SEBI-registered investment advisor. Please speak to a SEBI-registered advisor before you invest.