# Sum-of-the-Parts Valuation (SOTP)

## Unlocking Value with Sum-of-the-Parts Valuation

When it comes to valuing a complex, multi-divisional company, traditional valuation methods can sometimes paint an incomplete picture. This is where Sum-of-the-Parts Valuation (SOTP) comes into play. SOTP is a nuanced approach that breaks down a conglomerate into its constituent businesses and values each separately. By doing so, investors and analysts can uncover hidden value that might be overlooked by more conventional valuation methods. In this article, we'll delve into the intricacies of SOTP, explore its advantages, and examine real-world examples to illustrate its practical application.

## Understanding Sum-of-the-Parts Valuation

Sum-of-the-Parts Valuation is a method of valuing a company by analyzing each of its business units or subsidiaries independently. The core idea is that the sum of these individual parts may be greater than the current market value of the entire company. This approach is particularly useful for diversified companies with distinct segments that may be undervalued or overshadowed when considering the company as a single entity.

### When to Use SOTP

• Valuing conglomerates with diverse business units
• Assessing companies planning to spin-off or divest certain segments
• Understanding the value drivers of different segments within a company
• Identifying undervalued assets within a company's portfolio

### Steps in Conducting SOTP Valuation

• Identify and segregate the individual business units
• Choose the appropriate valuation method for each unit
• Calculate the value of each separate unit
• Sum the parts to arrive at the total company value

SOTP Valuation offers several advantages over traditional valuation methods. It provides a more detailed view of a company's worth by recognizing the unique characteristics and growth prospects of each business unit. This method can also highlight inefficiencies or synergies within the company that may not be apparent when looking at the company as a whole. Additionally, SOTP can be a powerful tool for investors considering activist positions, as it can reveal opportunities for restructuring or divestitures that could unlock shareholder value.

## Challenges and Considerations

While SOTP can be incredibly insightful, it's not without its challenges. One of the main difficulties is obtaining accurate and detailed financial information for each business unit, which is not always publicly available. Analysts must also be careful to apply the most appropriate valuation method for each segment, which can vary depending on the industry and the nature of the business. Furthermore, it's crucial to account for synergies and shared costs between units, which can affect the overall valuation.

## Real-World Examples of SOTP in Action

Let's look at some real-world examples where SOTP has been effectively applied:

### Case Study: General Electric

General Electric (GE) is a classic example of a company where SOTP analysis has been particularly relevant. As a conglomerate with operations ranging from aviation to healthcare to power, GE's overall value has often been debated. Analysts have frequently used SOTP to argue that the company's share price did not fully reflect the sum of its parts, suggesting that GE could unlock value by spinning off certain divisions or restructuring its operations.

### Case Study: Alphabet Inc.

Alphabet Inc., the parent company of Google, provides another interesting case. While its core advertising business is well understood, Alphabet also includes a range of other ventures, such as Waymo (autonomous vehicles), Verily (life sciences), and Google Cloud. An SOTP valuation can help investors understand the potential of these other businesses that are often overshadowed by the company's dominant search and advertising segment.

## Conclusion: The Sum is Greater Than Its Parts

In conclusion, Sum-of-the-Parts Valuation is a powerful tool for investors and analysts looking to get a granular view of a company's worth. By valuing each business unit separately, SOTP can uncover hidden value and provide a more accurate representation of a company's true potential. While it requires a detailed understanding of each segment and careful consideration of the appropriate valuation methods, when done correctly, SOTP can reveal opportunities for value creation that might otherwise remain hidden.

Whether you're an investor considering a position in a diversified company or an analyst seeking to understand the drivers of value within a complex organization, SOTP is an essential technique to have in your financial toolkit. By breaking down a company into its constituent parts, you can gain insights that are not just additive but multiplicative, unlocking value and opportunities for strategic decision-making.