Why Valuations Differ by Industry

Valuations are a crucial aspect of finance that help investors and businesses determine the worth of an asset or company. However, the valuation of a company can vary significantly depending on the industry it operates in. In this article, we will explore some of the reasons why valuations differ by industry and include a real-world comparison between a manufacturing business and a software company to illustrate the concept. We will also discuss other factors that can lead to different valuations for companies within the same industry.

1. Revenue and Profitability

One of the primary factors impacting a company's valuation is its revenue and profitability. Industries with higher revenue growth and profit margins tend to command higher valuations. Consider a technology company that generates consistent double-digit revenue growth and 70-80% gross margins. Investors are willing to pay a premium because such companies can scale rapidly without incurring significant costs.

Contrast this with a restaurant or manufacturing company, where margins are much tighter—sometimes as low as 10-15%. These industries are more capital-intensive, requiring significant ongoing investment to maintain operations, which limits profitability and results in lower valuations. In essence, investors place a premium on companies that generate more revenue per dollar spent and have greater scalability.

Example: Imagine two companies with the same annual revenue of $10 million: Company A, a software firm, and Company B, a manufacturer. Company A operates with 80% gross margins, while Company B operates with 20%. Even though their topline numbers are identical, Company A’s ability to convert revenue into profit drives a much higher valuation.

2. Growth Potential

Growth potential is another critical factor that explains why industries are valued differently. Investors often look for future opportunities to earn a return, and industries with higher growth trajectories tend to receive higher valuations.

Software companies, for instance, are often seen as having limitless potential for growth because they can tap into global markets quickly and scale their operations with minimal incremental costs. In contrast, industries like manufacturing or utilities are typically seen as mature, with growth constrained by physical capacity or geographic limitations.

A personal experience that comes to mind is a deal I was working on between a regional manufacturing business and a software-as-a-service (SaaS) company. The manufacturing company had been around for decades, consistently growing 5% annually. Meanwhile, the SaaS company, though younger, was doubling its revenue every year. The software company’s valuation ended up being 10x revenue, while the manufacturer traded at a more modest 1.5x revenue. The rationale was clear: investors valued the explosive growth potential of the SaaS company far more than the steady, predictable performance of the manufacturer.

3. Asset Intensity

The asset intensity of an industry—or how much capital it requires to operate—is another key factor that influences valuations. Asset-heavy industries, such as manufacturing, transportation, and energy, tend to have lower valuations because they require significant investments in machinery, infrastructure, and physical assets.

On the other hand, asset-light industries like software, consulting, and media require far fewer physical resources to generate revenue. This allows for higher profit margins and greater operational flexibility, both of which attract higher valuations.

Case Study: Take a manufacturing plant that produces automotive parts. The company must invest millions of dollars in specialized machinery and facilities, which depreciate over time. This capital-intensive model results in slower returns on investment. Now, compare this to a software company offering cloud-based analytics solutions. The software company’s primary assets are its intellectual property and people—both of which require relatively little capital investment but can generate recurring revenue at high margins.

4. Regulation and Legal Environment

The regulatory and legal landscape also plays a significant role in determining industry valuations. Industries with heavy regulatory oversight, such as healthcare, financial services, and energy, often face higher costs of compliance, operational complexity, and legal risks. These factors can weigh on profitability and ultimately suppress valuations.

By contrast, industries like technology or consumer goods often face less regulatory scrutiny, giving companies greater freedom to innovate and scale quickly. However, this isn’t always absolute—new regulations can emerge rapidly in sectors like fintech or data privacy, sometimes causing unexpected shocks to valuations.

Example: A medical device company may face years of clinical trials, FDA approvals, and compliance costs before bringing a product to market. While the potential rewards are significant, the regulatory hurdles mean slower growth and greater risk for investors, which limits valuation multiples. On the other hand, a direct-to-consumer e-commerce brand can launch and scale with fewer barriers, resulting in a faster path to valuation growth.

5. Competitive Landscape

The level of competition within an industry can also impact valuations. Industries with high competition, such as retail, hospitality, and consumer goods, often experience compressed profit margins and slower growth. When numerous players compete for the same customers, pricing pressure increases, eroding profitability.

In contrast, industries with fewer competitors, such as biotechnology or specialized software, tend to enjoy higher valuations due to their unique products or market positioning. Companies in these industries can establish pricing power and defend their margins, making them more attractive to investors.

6. Factors Beyond Industry: Comparing Two Manufacturers

Even within the same industry, valuations can differ significantly due to company-specific factors. These include:

• Operational Efficiency: Companies with streamlined operations, better supply chains, or advanced technology can operate at higher margins and command higher valuations.
• Brand and Market Position: A company with a strong market position or established brand can secure pricing power and customer loyalty, resulting in higher valuations.
• Revenue Mix: Companies with recurring revenue streams or diversified product lines tend to be valued higher than those with single-product dependency.
• Management and Strategy: Strong leadership and a clear growth strategy can differentiate two otherwise similar companies in the same industry.

Example: Imagine two manufacturers producing industrial tools. Company A has invested heavily in automation and technology, reducing costs and improving margins. Company B, on the other hand, relies on older equipment and faces higher operating costs. Despite operating in the same industry, Company A’s superior efficiency allows it to achieve higher profitability and a higher valuation multiple. Additionally, if Company A has diversified its product line to include service contracts, it could command an even higher premium due to its recurring revenue model.

A Real-World Comparison: Manufacturer vs. Software Company

To bring these concepts together, let’s compare a traditional manufacturing business with a software company.

• Company A (Manufacturer): A family-owned business that produces industrial equipment. It operates in a mature market with 5% annual growth. Margins are tight due to high input costs and competitive pressures, and the company has significant capital tied up in machinery and facilities. Its valuation may land at around 5-6x EBITDA (earnings before interest, taxes, depreciation, and amortization).
• Company B (Software): A cloud-based platform providing subscription analytics tools. The business has 40% annual revenue growth, 80% gross margins, and requires minimal physical infrastructure. Investors value its potential to scale quickly and dominate a niche market. Its valuation might be 10-15x EBITDA—or higher if growth accelerates.

While Company A is a solid, reliable business, Company B represents exponential upside, which investors are eager to reward. This highlights how factors like growth potential, asset intensity, and margins influence valuations across industries.

Conclusion

Valuations can differ significantly by industry due to a variety of factors, including revenue and profitability, growth potential, asset intensity, regulation, and competition. However, even within the same industry, companies can be valued differently based on their operational efficiency, market position, revenue mix, and management strategy.

Understanding these nuances is critical for investors, business owners, and executives when assessing the worth of a company. In my experience, seeing two businesses—one a legacy manufacturer and the other an innovative SaaS provider—get valued so differently provided a valuable lesson. Valuations are not just about numbers; they reflect the market’s perception of opportunity, risk, and growth. Recognizing these dynamics helps us appreciate why a dollar earned in one industry—or even in the same industry—is often valued so differently in another.