======Sum-of-the-Parts (SOTP)======
Sum-of-the-Parts (SOTP) analysis is a valuation method that breaks down a company into its various business divisions and values each one separately, as if it were a standalone enterprise. The idea is to calculate what each piece would be worth on its own, add them all up, and then make adjustments for corporate-level assets and liabilities. The final figure represents the company's intrinsic value, often called its "break-up value." Think of it like a meticulous antique dealer appraising a grand estate: instead of just slapping a price on the whole property, they value the mansion, the stables, the vintage car collection, and the vineyard individually to arrive at a truer, more comprehensive worth. For investors, this total value is then compared against the company's current [[market capitalization]]. If the SOTP value is significantly higher, it might signal that the market is overlooking hidden gems within the company, presenting a classic [[value investing]] opportunity.
===== How Does SOTP Valuation Work? =====
While the concept is simple, the execution requires some detective work. At its core, the process involves peeling back the layers of a company to see what's truly inside.
==== The Step-by-Step Guide ====
  - **Step 1: Identify the Segments.** Your first stop is the company's annual report (like the [[10-K]] filing in the US). Companies are required to report financial information for their distinct operating segments. This is your treasure map, showing you the different businesses hiding under one corporate roof.
  - **Step 2: Value Each Segment.** This is the art and science of SOTP. You must assign an appropriate valuation metric to each business unit based on its characteristics. For a stable, mature manufacturing division, you might use a multiple like [[EV/EBITDA]]. For a fast-growing, not-yet-profitable tech startup within the company, a [[Price/Sales]] multiple might be more suitable. You'll look at comparable public companies (comps) for each segment to find a reasonable multiple to apply.
  - **Step 3: Sum the Parts.** Once you have a value for each business segment, you simply add them together. This gives you the total Enterprise Value of the company's operations.
  - **Step 4: Adjust for Corporate Items.** This is a crucial step. From the total value of the operations, you must subtract the company's net debt (Total Debt - Cash). You also need to account for other corporate-level items that don't belong to any single division, such as unallocated corporate overhead, pension liabilities, or the value of a corporate headquarters. After these adjustments, you arrive at the company's total [[equity value]].
  - **Step 5: Compare and Conclude.** Divide the final equity value by the number of shares outstanding to get a per-share SOTP value. Now, compare this to the current stock price. Is it 30%, 50%, or even 100% higher? If so, you may have found a bargain.
===== Why is SOTP a Value Investor's Best Friend? =====
SOTP isn't just a number-crunching exercise; it's a mindset that helps you think like a business owner and spot opportunities the market has missed.
==== Uncovering Hidden Value ====
SOTP analysis shines brightest when analyzing [[conglomerates]]—companies operating in multiple, often unrelated, industries. The market can struggle to understand these complex beasts, often applying a "conglomerate discount" and valuing them lower than their individual parts would command. SOTP helps you cut through the complexity.
Imagine a boring, slow-growing industrial parts company that also happens to own a small but rapidly expanding cloud software business. The market might only see the smokestacks and value the whole company on a low industrial multiple, completely missing the high-growth tech gem buried in the financial statements. A SOTP analysis would value the two separately, revealing the company’s much higher true worth.
==== Identifying Catalysts for Value Realization ====
A big gap between the SOTP value and the stock price is great, but how will that value be unlocked? The SOTP analysis helps you identify potential events, or [[catalyst]]s, that could force the market to recognize the company's true value.
  * **Spinoffs:** The company could execute a [[spinoff]], turning a division into a new, independent public company. Shareholders of the parent company typically receive shares in the new entity.
  * **Divestitures:** Management might sell a business unit outright to another company, often for a handsome price that highlights its standalone value.
  * **Activist Pressure:** An [[activist investor]] may build a significant stake in the company and publicly campaign for management to sell or spin off divisions to unlock value for all shareholders.
===== The Pitfalls of SOTP Analysis =====
Before you rush off to break up every company on paper, be aware of the potential traps. SOTP is a powerful tool, but like any tool, it can be misused.
==== Garbage In, Garbage Out ====
The final SOTP value is extremely sensitive to your assumptions. If you choose an overly optimistic valuation multiple for a key division or use flawed data, your entire conclusion will be wrong. Rigorous and conservative assumptions are key.
==== The Synergy Trap ====
Sometimes, 2 + 2 really does equal 5. A naive SOTP analysis assumes you can separate businesses without losing anything in the process. However, it completely ignores [[synergy]]—the benefits the businesses gain from being together. This could include shared R&D, a common sales force, or lower administrative costs. Breaking them up could destroy this value, meaning the whole is actually worth //more// than the sum of its parts.
==== The Conglomerate Discount is Sometimes Justified ====
While SOTP can reveal an //unwarranted// discount, sometimes the discount is there for a good reason. A company's central management might be inefficient, misallocating capital to failing divisions instead of investing in promising ones. In these cases, the market is correctly penalizing the company for poor corporate stewardship. A sophisticated analyst will often apply a 10-25% "corporate discount" to their final SOTP calculation to account for these real-world frictions and potential value-destruction from the head office.