Sum of the parts analysis (SOTP), or break-up analysis, is a method of valuation of a multi-divisional company, holding company, or a conglomerate. The essence of the method is to determine what divisions would be worth if the conglomerate is broken up and spun off or acquired by another company;
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see Conglomerate discount. The analysis calculates a range of values for a conglomerate’s equity by summing the value of its individual business segments or divisions to get the total conglomerate’s enterprise value. The equity value is then calculated by subtracting net debt and other non-operating adjustments. There is a rich literature that explores the valuation practices of financial analysts.

• The discounted cash flow technique is a method of valuation in which the discounted future cash flows of a business are used in the valuing of the business.
• Earlier-stage therapeutic assets, compared to those in the later stages of obtaining regulatory approval (or even commercialization), have a far lower probability of success and are therefore inherently riskier.
• It also reviews the literature on the usefulness and value relevance of segmental information.
• The strength of this approach is that we can use different metrics across the band of the different business units within the company.

The fourth section reports and discusses the main findings of our empirical research. The discounted cash flow technique is a method of valuation in which the discounted future cash flows of a business are used in the valuing of the business. DCF is also applicable to the valuing of the future cash flow of a business segment, division or project using a discount rate. In most cases, DCF is a valuation tool that is incorporated into Sum-of-parts valuation (SOTP), it is used to determine the value of the segments or units of a business. In the formula above, ND means net debt, NL means non-operating liabilities while NA refers to non-operating assets. Using the above formula, the value of each of the business is derived separately first before they are aggregated or summed up to realize the value of the firm or company as a whole.

As previewed above, SOTP refers to the practice of segmenting businesses into different parts for the purposes of valuation or financial modeling. When employing this tactic, your model will have different builds for revenue and expenses across each of the ‘Parts,’ ultimately building to segment-level EBITDAs. From there, the sum of each of the segment-level EBITDAs will generally equal the EBITDA of the whole company (WholeCo). Now that we have our enterprise values, let’s look up the Cash on hand, debt, and shares outstanding from the annual reports.

To do so, ask yourself what the key value drivers are and whether or not one segment is driving/distorting the overall company value. We’ll now move to a modeling exercise, which you can access by filling out the form below. Earlier-stage therapeutic assets, compared to those in the later stages of obtaining regulatory approval (or even commercialization), have a far lower probability of success and are therefore inherently riskier. The product-level assumptions are intended to address the uncertainties surrounding a product’s path to commercialization, namely the clinical FDA trials as part of the regulatory approval process.

Sum of Parts Valuation – Explained

In this article, we will perform a Sum of the Parts Valuation Model (“SOPM”), which is widely used by analysts. By wearing “Wall Street glasses”, we could better assess if there could be a potential upside from the relative valuation with Peers despite the strongly adverse market conditions. Also one needs to understand that the SOTP model does not take the tax implications into consideration. The company as a whole pays one tax irrespective of the profits / losses the sub businesses tend to make. Any valuer will identify this as a bad business as the company can go bust if the loan turns out to be a bad loan.

The last thing you need is a disorganized mess — you’ll hate your life and be way more likely to make mistakes. The above valuation method is fairly straightforward, sum of the parts valuation but as you will see below, there are a few cons to this valuation style. Ok, I will put a simple table together to outline the possible multiples for each segment.

How valuation approach choice affects financial analysts’ target price accuracy

If one goes to value the entire stock of RIL as a whole, it may give values that may not logically support the argument. On this page, we discuss the sum of the parts valuation approach and discuss a sum of the parts valuation example. Just don’t forget to subtract net debt and any non-operating items, then you’re good to go. At the highest level, your Excel tab structure will become more important in an SOTP model. With multiple parts, you’ll need to make sure that your model is easy to navigate, both for yourself and for anyone else who looks at your work.

Some would disagree with this adjustment and say that we should use only SunPower’s pre-spin-off share count. For example, if neither division has an Accounting team but instead depends on “corporate headquarters” for this function, we need to subtract the capitalized version of that expense. Once we have all these individual pieces, we can put them together to estimate the value to shareholders if this spin-off proceeds as planned. In this SunPower / Maxeon example, a few steps are slightly different because it uses a real-life spin-off with proposed deal terms.

But solar manufacturing accounted for only about half of SunPower’s revenue, so management and investors felt the company was undervalued. Here, the comps-derived valuation is estimated using the “Low” and “High” end of the EV/EBITDA multiple ranges pulled from each segment’s peer group. One sector in which SOTP analysis is relied upon is the biotech sector, particularly for clinical-stage, pre-revenue companies.

Target price accuracy: International evidence

Since this is a spin-off that happened in real life, we want to reflect that SunPower shareholders received 0.125 Maxeon shares for each 1 SunPower share. 1) We’ve already re-allocated corporate overhead costs appropriately in the separate models. We build sensitivity tables based on the Discount Rate, Terminal Growth Rate, and Terminal Multiple to determine the range of Implied Enterprise Values for each division.

The value estimated from this approach is called the breakup value or private market value. The most common use of the sum of the parts valuation is to value a company made up of different business units across multiple industries. This type of valuation makes sense because multiples or valuations differ across industries. Sum-of-the-parts analysis estimates the TEV of the parent by adding up the individually estimated TEVs of the companies involved. If a company is controlled by the parent then its TEV is already part of the parent’s TEV.

Steps in Performing SOTP Valuation Analysis

Some researchers conduct interviews of financial analysts (Barker, 1999), while others undertake content analysis of their equity research reports (Demirakos, Strong, & Walker, 2004). Most of the studies find widespread use of relative valuation techniques based on earnings (Asquith, Mikhail, & Au, 2005; Block, 1999; Bradshaw, 2002). The sum-of-the-parts valuation (SOTP) refers to a method of valuing a firm by evaluating or assessing each of its divisions separately before their values are aggregated. This means that all the divisions or segments of the business are evaluated distinctly and then summed up to realize the value of the firm. SOTP is used to determine the equity of a company, it entails valuing all its business entities before a single total enterprise value (TEV) is arrived at.

To value the different parts of a business, several inputs are needed and this is really demanding. Another limitation of the Sum-of-parts valuation (SOTP) is its failure to account for tax implications, this method gives no consideration for tax. On the lower end of the valuation range, the implied equity value of our company is $860m, whereas, on the higher end of the range, the implied equity value is $1.24bn. Clearly, Segment A contributes the most EBITDA to the company, but the total firm valuation multiple appears to be weighed down by its comparatively lower EV/EBITDA multiple.

The valuation of the company can go to positive or negative depending on the type of investment. A company has numerous assets under it’s name, the loans it takes to fund the business and the sources of revenue. It becomes a tedious task to monitor the overall well being of the company with just a bird eye view. These collections of business are valued independently and then clubbed to form a singular valuation model for the stock. There is no doubt it will come up over and over again through your career, and can be a helpful tool in your toolkit.

Before the spin-off, SunPower was a solar manufacturing, installation, and services company, but it had always traded at a significant discount to pure-play solar installation/services companies. Despite the uses of the Sum-of-parts valuation (SOTP), it has certain limitations or drawbacks. The major limitation of the Sum-of-parts valuation (SOTP) is that it is a rigorous process that requires many inputs.

SOTP provides an insight into the value of a firm if its units or divisions were to be taken over by another firm. The value of each business unit or segment is derived separately and can be determined by any number of analysis methods. For example, discounted cash flow (DCF) valuations, asset-based valuations and multiples valuations using revenue, operating profit or profit margins are methods utilized to value a business segment. Sum-of-the-parts (“SOTP”) or “break-up” analysis provides a range of values for a company’s equity by summing the value of its individual business segments to arrive at the total enterprise value (EV). Equity value is then calculated by deducting net debt and other non-operating adjustments.

This guide will provide background on the methodology, cover how to employ it yourself, and just give you a real explanation of the term if you’re simply curious about the meaning of SOTP. The sum of the parts valuation remains a big weapon used by sell-side analysts when determining a company’s value or price. They look at others in the same industry for each business segment and price it accordingly. The analysts see it as a way of extracting value from each segment as a standalone business.

Now that we know the segments and what kind of products they deliver, we can determine what industry they are closest to and find comparable metrics. For example, if the business has under its umbrella segments such as automobiles, oil and gas, software, and a bank, we can use the P/E ratio, EV/EBITDA, Price to Book ratio, and EV/Sales, respectively. Using the sum of the parts valuation on holding companies or conglomerates like Berkshire Hathaway, GE, or United Technologies is a great way to value those companies. The overall conclusion is that if this spin-off is even slightly successful, the SunPower shareholders should see a big increase in the value of their shares.