Sum of the Parts Valuation: Tutorial and Excel Example

Using a DCF remains difficult because calculating cash flows for a bank can prove challenging. The sum of the parts valuation, also known as the breakup analysis, helps investors understand the company’s true value. By breaking up the different parts of the business, you can determine which segments offer the most value, and it can also help you determine what segment drives the most value for the business.

The next step is to determine which industry each segment lines up with so we can determine what to use for our multiples. Now that we see the breakout of the different segments of 3M, let’s find the operating incomes for each segment per the annual report. The company I would like to value using the sum of the parts valuation is 3M (MMM), the conglomerate dividend aristocrat with a current market price of $157.27 and a market cap of $90.33 billion. The strength of this approach is that we can use different metrics across the band of the different business units within the company. Before we get started with each case, we shall calculate each company’s individual TEV. At the moment we are ignoring the % equity ownership of the parent within each entity.

Sum of the Parts Valuation: Conclusions for SunPower and Maxeon

In reality it’s also hugely helpful for any business with disparate divisions or offerings. The last issue with using a sum of the parts valuation relates to a pricing game, not necessarily a valuation. When we use multiples to arrive at a valuation, we enter the arena where the price becomes a more important variable than the business’s cash flows. Pricing depends on market forces, whereas cash flows depend on the business’s operations and management decisions. Using the sum of the parts valuation is a simple, straightforward method of valuing companies.

Palantir Commercial business has the steady recurring structure of the biggest B2B SaaS players while also approaching consumption-based pricing, which provides more growth potential. From the following table, we understand the entire business structure of Reliance Industries by better understanding the sub businesses it has under it. We can also identify which of the sub business performs well and which one incurres losses.

• 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.
• The analysts see it as a way of extracting value from each segment as a standalone business.
• A company valuation for a food industry may be completely different from that of an aviation industry.
• In the General Electric scenario, it’s obvious that you will need different revenue and expense builds for each segment of the business.

Each of these will have totally different product offerings, revenue models, cost bases, and valuations. We’ll cover this in more detail later, but these segments are also helpful to piece together individual valuations. You can apply different multiples (such as EV / EBITDA or other) to the financials of each segment to arrive at an isolated value for that business line. When added together, the sum of the individual values will be your estimate of the value of the WholeCo business. Once we have the value of each of the segments, we add up the parts, giving us the enterprise value of the equity; then, we add the Cash and cash equivalents, then subtract the debt.

An analysis of the impact of adopting IFRS 8 on the segment disclosures of European blue-chip companies

In situations such as this one, larger companies have the ability to take advantage of synergies and economies of scale unavailable to smaller companies, enabling them to maximize a division’s profitability and unlock unrealized value. A company valuation for a food industry may be completely different from that of an aviation industry. For an investor, it showcases like as if the entire business is suffering the burden of a loan.

You might skip this step for private companies because share prices are less meaningful there. And if the expenses for these services are not included in the separate financial statements, each division’s profitability might be overstated. One problem with analyzing the divisions separately is that they often need services that the larger parent company provides. (6) Divide by the sum of diluted shares outstanding to arrive at a range of equity values per diluted share.

If a company is not controlled by the parent, then only the relevant equity investment is part of the parent’s total equity and hence its TEV. 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. For calculating the EVs of each individual entity we shall use the EBITDA multiple method, but you can use any other valuation methodology such as DCF.

What is sum of the parts (SOTP) valuation?

Your model should have a consolidated view of the business with clear breakdowns of the different parts. This will most likely take the form of a consolidated Income Statement, with revenue, expense, and EBITDA subtotals reflecting the business lines included. For simple models, keep each part isolated on different tabs, with revenue and expenses building to EBITDA for that segment. Now that we’ve covered types of businesses where an SOTP approach is helpful, we can now talk about a few practical applications. Note that SOTP is helpful and used frequently in standard M&A and capital raising transactions, but these specific scenarios are even more tailored to the approach. The most important point for this business will be the difference in value between the two segments.

A company in this case may take a loan to establish one leg of business and the rest businesses may run just fine. This dynamic is reflected by applying different multiples to each segment, say 8.0x EV / EBITDA for the physical printing and 15.0x EV / EBITDA for the eCommerce business. The sum of the parts valuation offers us an effective tool to find the value of different segments of any business you want to value. It is a simple, straightforward way to value any business with more than one line of business. To value each unit of the business, we must follow multiple steps to set up the valuation.

Ok, now that we understand the sum of the parts valuation and the process involved, let’s calculate a few to give us a sense of how this works. We can use relative valuation metrics such as P/E ratio, EV/EBITDA, Price to Book ratio, and PEG ratio. The sky is the limit on metrics; make sure you use ones that you can easily quantify, remain sure of the definitions, and stay consistent. Think of Berkshire, which contains many different businesses under the same umbrella. As you will see through this post, valuation sounds scary, but it is quite simple once you understand the process and where to find the different parts to calculate. SunPower claims that it can reduce costs more effectively to compete with the Chinese solar PV companies that way, but we don’t have enough information to say for sure.

It focuses on measuring the value of a business with distinctively different divisions or varying degrees of equity investments in other companies. By doing so you can achieve a more accurate valuation than only using earnings, the balance sheet and cash flows. The Sum of the Parts Analysis (SOTP), or “break-up analysis”, estimates the value of each business segment within a company separately, which are then added together to arrive at the company’s implied total enterprise value. While both are valuation tools, the SOTP valuation can incorporate a discounted cash flow (DCF) valuation. Meanwhile, the DCF uses discounted future cash flows to value a business, project or segment. The SOTP valuation is most commonly used to value a company comprised of business units in different industries since valuation methods differ across industries depending on the nature of revenue.

How To Value Stocks Using Sum Of The Parts (SOTP) Valuation Model

This section will cover some common best practices to ensure you build a great sum-of-the-parts model and valuation. A breakup value above a company’s going concern value may prompt a divesture or a spin-off. Remember, the price we pay is important, and learning to value a business is an important skill to learn, practice, and, hopefully, master one day. For example, Disney could be on the ropes with the shutdown of theme parks and movie theaters. Still, by utilizing a sum of the parts valuation, you can see that Disney derives some of its value from other parts of its business, and if it can hang on until the health situation starts to improve, Disney can climb out of any hole.

• The sum-of-parts valuation model values a company by aggregating the estimated value of its different segments valued as if they were independent.
• To come up with an estimate of the enterprise value of the firm, the analyst adds the separate value estimates of the individual segments.
• The value estimated from this approach is called the breakup value or private market value.
• 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.
• 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.

For this example we shall use a diversified company with three distinct businesses – a retailer with brick and mortar retail operations, real estate assets and online operations. All 3 cases have the same sub-entities but the difference lies in the % of equity ownership of the parent within each entity. 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).

When to Use SOTP Valuation

The sum-of-the-parts (SOTP) valuation involves valuing various business segments, and more valuations come with more inputs. As well, SOTP valuations do not take into account tax implications, notably the implications involved in a spinoff. Sum-of-the-parts valuation, also known as breakup value analysis, helps a company understand its true value. For example, you might hear that a young technology company is “worth more than the sum of its parts,” meaning the value of the company’s divisions could be worth more if they were sold to other companies. The overall value of the company may be positive, but we need to also segment out the individual businesses under it to get the real picture.

Then we take enterprise value and subtract the debt and other non-operating assets and expenses. The following spreadsheet demonstrates how to set up the sum-of-the-parts analysis for a publicly traded company. Note that the analysis will typically calculate the premium/discount to the current share price to suggest whether or not the public company is worth more or less when separated into its individual businesses. For a company with different business segments, each segment is valued using ranges of trading and transaction multiples appropriate for that particular segment.

It is also used to estimate the value that can be unlocked from a restructuring like a spin-off, split-off, or equity carve-off. Any time we use either one of those data points, there are interpretation error possibilities. And the more inputs, the more likely we, the investor, make a mistake which could lead to mistakes in investment choices. Sometimes the simplest model is the best model, not using complicated models for complicated sake.

Relevant multiples used for valuation, depending on the individual segment’s growth and profitability, may include revenue, EBITDA, EBIT, and net income. A DCF analysis for certain segments may also be a useful tool when forecasted segment results are available or estimable. In the General Electric scenario, it’s obvious that you will need different revenue and expense builds for each segment of the business. The company has (or had) offerings across aviation, healthcare, and financial services, among many others.