Valuing Each Piece of a Company Separately and Adding Them Up
A company with several different businesses can be worth more than a single multiple suggests. Sum of the parts values each division on its own and adds them, often revealing hidden value.
When One Multiple Is Not Enough
A company that operates several different businesses is often valued as a single entity on a single multiple, as if it were one uniform business. But its divisions may be very different, a fast growing one, a stable one, a declining one, each of which the market would value differently if it stood alone.
Sum of the parts valuation, sometimes abbreviated SOTP, values each business separately, applying an appropriate multiple or method to each, and adds them together to value the whole. It frequently reveals that a company is worth more than its single multiple valuation suggests, because the market has applied one average multiple to a collection of pieces that deserve different ones.
Valuing a diverse company on one multiple treats a fast grower and a declining business as if they were the same. Separating them often shows the whole is worth more than the market pays.
How It Works
The method breaks the company into its distinct businesses and values each with the approach best suited to it.
| Division | Valued on |
|---|---|
| High growth software unit | A high revenue or earnings multiple |
| Stable industrial unit | A moderate earnings multiple |
| Real estate holdings | Property value |
| Stake in another company | Market value of the stake |
Each piece is valued as if it were a standalone company, using the multiple or method that a comparable independent business would command. The values are summed, and then adjustments are made for company wide items, corporate debt, unallocated costs, the head office, to arrive at a value for the whole.
Why It Reveals Hidden Value
Sum of the parts often shows a higher value than the market gives because a diversified company tends to be valued at a blended multiple that undervalues its best pieces. A company with a fast growing division buried inside a slow growing conglomerate may be valued as a slow grower overall, so the market misses the value of the fast growing part.
This gap between the sum of the parts and the market value of the whole is the conglomerate discount, the tendency of diversified companies to trade below the combined value of their separable pieces. The discount reflects the market difficulty in valuing a complex mix, the inefficiency of running unrelated businesses together, and the lack of focus that diversification can bring.
The Strategic Consequence
Sum of the parts is not just an analytical exercise; it drives real corporate decisions. When the parts are worth more than the whole, there is pressure to separate them, through a spinoff, a sale of a division, or a breakup, to realise the hidden value.
Activist investors frequently use sum of the parts analysis to argue that a company is undervalued and should break itself up, unlocking the value the conglomerate discount conceals. When a company spins off a division and the combined value of the two separate companies exceeds the prior value of the single company, the sum of the parts thesis has been proven, and the conglomerate discount has been captured. This is a common reason companies break themselves apart.
The Limits and Traps
Sum of the parts has real weaknesses that can make it misleading. The multiples applied to each division are estimates, and choosing generous multiples for each piece can produce an inflated total that overstates the value, a common way the analysis is abused to argue a company is cheap.
It also ignores the reasons the businesses are together, which sometimes include genuine synergies, shared costs or capabilities that would be lost if separated. Valuing the pieces separately assumes they can be cleanly separated and that the separation itself is costless, which is not always true. And the corporate level costs and debt must be allocated carefully, since ignoring them overstates the value of the parts. Used honestly it reveals real hidden value; used carelessly it manufactures value that separation would not actually deliver.
The Bottom Line
Sum of the parts valuation values each of a company businesses separately and adds them, often revealing that a diversified company is worth more than its single blended multiple suggests, a gap known as the conglomerate discount. It drives real decisions, since parts worth more than the whole invite spinoffs and breakups that activists push to unlock the hidden value. The method is powerful and easily abused, since generous multiples on each piece inflate the total, and it must account honestly for lost synergies, separation costs, and corporate level debt to avoid manufacturing value that a breakup would not actually realise.