Sum-of-the-Parts

A valuation method that values a company by appraising each of its business segments separately and adding them together.

Sum-of-the-parts (SOTP) is a valuation methodology where each of a conglomerate's or multi-segment company's divisions is valued independently as if it were a standalone entity. Because different business units may operate in entirely different industries, they often require different valuation metrics. For example, an analyst might value a mature manufacturing division using an EV/EBITDA multiple, while valuing a high-growth software division of the same company using a price-to-sales ratio. After calculating the individual enterprise values for each business segment, these figures are added together. To arrive at the total equity value of the parent company, analysts then add any corporate-level net cash or subtract corporate-level net debt, along with adjustments for unallocated corporate overhead or non-operating assets. Investors care about SOTP because it helps identify situations where a diversified company is trading for less than the aggregate value of its individual businesses. This discount is known as a conglomerate discount. Identifying a large gap between the market price and the SOTP valuation can signal an investment opportunity, particularly if management is planning a corporate restructuring, such as a spinoff or divestiture, to unlock that hidden value.

Company A has two divisions: a retail division with $100 million in EBITDA and a software division with $50 million in revenue. Comparable retail companies trade at 8x EBITDA, and comparable software companies trade at 6x sales. The parent company has $50 million in net debt. The SOTP valuation is calculated as: Retail Value ($100M 8 = $800M) + Software Value ($50M 6 = $300M) = Combined Enterprise Value of $1.1 billion. Subtracting the $50 million in net debt yields an estimated equity value of $1.05 billion.