Sum-of-the-Parts Valuation

Companies with different divisions may operate in industries with very different growth rates, risks and typical valuation multiples. Valuing the whole company with a single multiple can give a misleading result. Sum-of-the-parts analysis values each segment on its own terms.

For example, a conglomerate has three divisions: an industrial business valued at 8 times its earnings, a software business valued at 20 times and a property portfolio valued at the market value of its buildings. Each is valued separately, the values are added, and the company's net debt and any central costs are deducted to arrive at equity value.

Sum-of-the-parts valuation is often used for conglomerates, holding companies and companies considering break-ups or spin-offs. It can reveal whether the company's share price is lower than the combined value of its parts, a situation called a conglomerate discount.

Such a discount may suggest that selling or separating divisions could unlock value, which sometimes leads activist investors to push for a break-up. However, the discount may also reflect real costs, such as head office expenses, tax costs of separation or doubts about management.