Now that we have that determined, we can take the operating income from each segment and multiply them by the multiples from above to find our enterprise value. Finally, you can find the TTM (trailing twelve-month) numbers to calculate the valuation. A company such as Berkshire Hathaway contains a sum of parts of many businesses that consist of the operations of Berkshire. The company represents a sum of the parts of the insurance business, railroads, service, and investments. If you want to get to the bottom of what drives the earnings for Berkshire, the best method remains using a sum of the parts valuation.
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.
Subjective valuation and target price accuracy
SOTP valuations are often used when the target has several operating divisions in unrelated industries, each with different risk profiles. For instance, a conglomerate like Berkshire Hathaway, which states the following business divisions in its annual report. The valuation provides a range of values for a company’s equity by aggregating the standalone value of each of its business units and arriving at a single total enterprise value (TEV). The equity value is then derived by adjusting the company’s net debt and other non-operating assets and expenses. Sum of the parts (SOTP) is a type of valuation model for valuing the overall valuations of the company by breaking the business model into several small entities or smaller business models.
- 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.
- An SOTP financial model of the document printing business will require analysis of foot traffic, print volumes, pricing by document type, cost of paper, rent, store employees, etc.
- In this SunPower / Maxeon example, a few steps are slightly different because it uses a real-life spin-off with proposed deal terms.
- Some researchers conduct interviews of financial analysts (Barker, 1999), while others undertake content analysis of their equity research reports (Demirakos, Strong, & Walker, 2004).
- 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 based on the assumption that the business segments of the firm enjoy different profitability and growth characteristics. To come up with an estimate of the enterprise value of the firm, the analyst adds the separate value estimates of the individual segments. Despite its popularity among sophisticated practitioners and investors, SOTP is mostly ignored by researchers and academics.
Information content of equity analyst reports
As the name suggests, a SOTP valuation breaks up a conglomerate into the distinct business units and tries to value the different units separately. Then the enterprise values of the different business units are aggregated to arrive at an estimate of the conglomerate’s value. A sum of the parts valuation or break-up analysis is a valuation method that is used to analyse holding companies. Rather than trying to value the overall company, a sum of the parts valuation will determine the value of the different constituent companies or divisions.
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.
This offering is more recent and has smaller revenue/EBITDA, but will drive outsize value in a transaction. SOTP is commonly used when you’re modeling or valuing a company with different business lines. This may be a large conglomerate, such as General Electric, or a smaller company that has a few different offerings. I encourage you to experiment with this type of valuation to give you a better idea of the overall value of the business and the value of each part of the business. Sum of parts valuations offer a fantastic way to become more familiar with each business segment. We can also use them to compare the more traditional methods, such as a DCF, to see if those calculations are in the ballpark.
(5) Deduct net debt and add/subtract other non-operating/financial items from the EV range to determine a range of equity values. The first step is to determine what the appropriate business segments should be to value the firm. If they don’t, it may take some deeper digging to get a breakdown of performance across different parts of the company. It is commonly used to value conglomerates, holdings, and companies active in multiple industries. The SOTP methodology is not limited to the largest multinational conglomerates (as some textbooks might have you believe).
Sum of the parts valuation Excel
Valuation is part art, part math, and valuing a company encompasses many moving parts. Suppose we want to value a company and notice several different businesses tied up in the company. …but the installation and services segment could potentially trade at a much higher revenue multiple in the 4.0 – 5.0x range, in-line with comparable companies in that sector.
The company consists of three segments – Segment A, B, and C – which are each valued at different multiples and operate in different industries. As implied by the name, SOTP entails valuing each underlying piece of a company separately and then adding them together, rather than valuing the entire company in aggregate using traditional means. The Sum-of-the-parts valuation is also known as the breakup value as it assesses what individual segments would be worth if the company was broken up. The sum-of-the-parts valuation (SOTP) is a process of valuing a company by determining what its aggregate divisions would be worth if they were spun off or acquired by another company. There are many a times these large cap companies acquire many smaller companies along their way.
Video Tutorial: Sum of the Parts (SOTP) Valuation, With Excel Example
Then make sure you have clear inputs for multiples (or other valuation drivers) across each of the segments. Show a per segment valuation, and then show a sum of the segment-level valuations as your WholeCo valuation. Sum-of-the-parts, or SOTP, is a modeling and valuation approach frequently used by bankers and investors.
Say the physical printing business is quite a bit bigger in terms of both revenue and EBITDA. An SOTP financial model of the document printing business will require analysis of foot traffic, print volumes, pricing by document type, cost of paper, rent, store employees, etc. Conversely, the eCommerce model will require a view on number of printers sold, price of the printers, cost of goods for the printers, warehouse space, online advertising expense, etc. Sum-of-parts valuation values a company by aggregating the estimated value of its different segments valued as if they are independent. The inefficiency in the allocation of investment capital is one of the reasons a conglomerate discount would be applied to an estimated valuation.
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.
When calculating the SOTP of a company also, the net debt, non-operating assets, and nono-operating liabilities/expenses need to be adjusted. There are different analysis methods that can be used when calculating SOTP, one of these methods is the discounted cash flow (DCF). Sum Of The Parts (SOTP) valuation is an approach to valuing a firm by separately assessing the value of each business segment or subsidiary and adding them up to get the total value of the firm. It can be used in conjunction with various valuation techniques such as Discounted Cash Flow (DCF) modeling and comparable company analysis. We find the valuation by finding a range of values for the company’s equity by adding the standalone value of each segment of the business and finding a single enterprise value.
- SOTP (Sum of the parts) valuation model can also be clubbed with Discounted Cash flow model or other forms of valuation models for each division when a sub business is considered as a different company altogether.
- As a result, the company as separate entities could be worth more than the company as a single entity.
- 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.
- The company has (or had) offerings across aviation, healthcare, and financial services, among many others.
- …but the installation and services segment could potentially trade at a much higher revenue multiple in the 4.0 – 5.0x range, in-line with comparable companies in that sector.
For more complex models with advanced revenue and expense builds you’ll likely need multiple tabs for each segment. In this case, make sure they’re grouped together and all coded in the same color (use different colors for each segment). In a normal model this would drive the value of the business in a proportional manner. However, investors and the market are much more excited about the faster growing, higher margin, scalable eCommerce business.
We argue that the financial analysts’ choice to employ a greater number of segments in their SOTP models might be primarily driven by their effort to support their reports’ optimistic target prices. Our study extends the above literature by increasing our understanding of how financial analysts actually perform this type of segmental valuation exercise. In this way, we extend the relevant literature on the usefulness and value relevance of IFRS 8. Finally, we also assess the accuracy and forecast error of target prices derived by SOTP and DCF methods, when the latter model is used as a stand-alone model to value the company as a whole. Bradshaw (2011) claims that more research is needed on “what an analyst actually does? In the current study, we complement this literature stream by investigating how financial analysts apply a popular valuation approach, i.e. the Sum-of-the-Parts (SOTP) valuation framework.
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.