Sum Of The Parts SOTP Valuation Overview, Example, Steps

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.

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, 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.

SunPower and Maxeon: Rationale for the Sum of the Parts Valuation

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 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.

SOTP Meaning: Closing Thoughts

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 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.

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.

Sum of Parts Valuation

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.

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.

When to Use SOTP Valuation

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.

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.

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.

• While understanding enterprise value, bottom up, we will calculate the TEV of the parent by adding the individual enterprise values using the above M&A consolidation rules.
• By multiplying the EV/EBITDA multiple by the corresponding EBITDA metric for each segment, we can determine the segment enterprise values.
• They look at others in the same industry for each business segment and price it accordingly.
• The third section provides a description of the criteria that we apply to our data collection process and our empirical research design.
• Despite its popularity among sophisticated practitioners and investors, SOTP is mostly ignored by researchers and academics.

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.

Step 1. Segment-Level Financial Assumptions

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.

• In a normal Sum of the Parts Valuation, this step would be a simple matter of dividing the Implied Equity Value by the company’s share count (with support for a circular calculation for the diluted shares, if required).
• We are lucky because 3M lists all their segment data separately under the Management Discussion and Analysis (MD&A) sections, and they list out both their sales and operating income, or EBIT, which is the data we are looking to use.
• 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).
• A breakup value above a company’s going concern value may prompt a divesture or a spin-off.

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.