Sum-of-the-Parts (SOTP) or Summation Valuation

Sum-of-the-Parts (SOTP) or Summation Valuation

  • Values a conglomerate by summing the values of individual business units.

Procedures for Sum-of-the-Parts (SOTP) Valuation

Sum-of-the-Parts (SOTP) valuation is a method used to evaluate a company that operates in multiple businesses or segments. This approach allows analysts to assess the individual value of each business segment, rather than relying solely on a company-wide metric. Here are the key procedures involved in conducting a SOTP valuation:

1. Identify Business Segments

  • Breakdown the company into its core business units or segments.
  • Ensure each segment is distinct and has its own revenue and expense structure.

2. Gather Financial Data

  • Obtain the financial statements for each segment, including revenue, operating income, and capital expenditures.
  • Analyze historical performance to understand growth trends and profitability.

3. Choose Valuation Methods

  • Select appropriate valuation methods for each segment. Common approaches include discounted cash flow (DCF), comparable company analysis, and precedent transactions.
  • Ensure that the chosen method reflects the unique characteristics of each business unit.

4. Calculate Segment Values

  • Perform individual valuations for each segment using the selected methods.
  • Document the assumptions used in each valuation, such as discount rates, growth rates, and market comparables.

5. Compile Results

  • Add together the valuations of all segments to derive the total enterprise value of the company.
  • Consider any inter-segment synergies or adjustments that may affect overall value.

6. Adjust for Debt and Other Liabilities

  • Subtract total debt and any other liabilities from the total enterprise value to arrive at the equity value.
  • Evaluate any non-operating assets or liabilities that might influence the final valuation.

7. Analyze and Interpret Findings

  • Present the results to stakeholders, providing insights into each business segment’s contribution to the overall value.
  • Discuss implications for strategic decision-making, such as potential divestitures or restructuring efforts.