How sum of the parts (SOTP) valuation works for conglomerates

Some Indian companies run very different businesses under one roof, such as energy, retail and telecom. Valuing them with one ratio does not work well. Sum of the parts, or SOTP, valuation solves this. This page explains how it works and what to watch out for.

Quick answer

Sum of the parts (SOTP) is a valuation method that values each business segment or major holding of a company separately, using the method that fits each part, and then adds them together. Net debt and other adjustments are subtracted to reach equity value. It is widely used for conglomerates and holding companies whose businesses have very different growth, risk and valuation levels.

Key takeaways

• SOTP values each business segment separately.
• Each part can use a different method, such as DCF or multiples.
• Listed subsidiaries are often valued at market price.
• A holding company discount is often applied.
• It is common for conglomerates and diversified groups.

What is sum of the parts valuation?

A diversified company may have a slow-growing commodity business and a fast-growing consumer business. Putting one P/E ratio on the whole group would undervalue one part and overvalue the other. SOTP avoids this by valuing each part on its own terms.

The values of all parts are then added, and items like net debt at the parent level are subtracted. The result is an estimate of the group's total equity value.

How does it work, step by step?

Dividing the equity value by the number of shares gives a per-share value. The figures in the table are only for illustration.

What is the holding company discount?

When a parent company owns shares in a listed subsidiary, investors often value that stake below its market value. Reasons include taxes on dividends passing through layers, less direct control for shareholders and the chance that cash stays at the parent rather than reaching them.

Analysts often apply a discount, which can vary widely depending on the group and its governance. This discount can be large for some holding companies, which is why their share prices may trade well below the sum of their stakes.

When is SOTP used?

It is used for conglomerates, groups with many subsidiaries and companies planning a demerger. Announcements of a demerger often draw attention to SOTP, since separate listings can let the market value each business on its own.

Banks with insurance and asset management arms are also often valued this way, with each financial business valued separately.

What are the limits?

Each part needs its own assumptions, so errors can add up. Choosing the right discount is a matter of judgement. The parts may also share costs or benefits that are hard to split, so the total may not equal the real value of the group.

In short, sum of the parts breaks a complex group into pieces that are easier to value. It is a useful way to understand diversified companies, but the final number depends on many judgement calls.

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