# Understanding Sum-of-the-Parts Valuation: Meaning, Formula, and Example

## What Is the Sum-of-the-Parts Valuation (SOTP)?

The Sum-of-the-Parts (SOTP) valuation method values a company's divisions independently to determine their aggregate worth, particularly useful for firms with diverse industry units. Calculating the SOTP provides insights into the standalone value of each division, helping to reveal the [total enterprise value (TEV)](https://www.investopedia.com/terms/t/tev.asp)and the company's equity value by adjusting for net debt and [non-operating assets](https://www.investopedia.com/terms/n/nonoperatingasset.asp).

### Key Takeaways

*   Sum-of-the-Parts Valuation (SOTP) is a method for assessing a company's value by determining the worth of each individual division if spun off or acquired.
*   SOTP is frequently used for conglomerates with diverse business units, allowing for the evaluation of their separate valuations.
*   SOTP calculations provide a total enterprise value by combining standalone segment values and adjusting for net debt and non-operating items.
*   This valuation can be instrumental in defending against hostile takeovers by demonstrating a higher worth when parts are valued individually.
*   The SOTP provides insight into a company's actual value, sometimes revealing that a company's divisions are worth more separately than together.

## The SOTP Valuation Formula

﻿ $\begin{aligned} &\text{SOTP} = N_1 + N_2 + \dotso + ND - NL + NA \\ &\textbf{where:}\\ &N_1=\text{Value of first segment}\\ &N_2=\text{Value of second segment}\\ &ND=\text{net debt}\\ &NL=\text{nonoperating liabilities}\\ &NA = \text{nonoperating assets} \end{aligned}$﻿

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

The value of each business unit or segment is derived separately and can be determined by any number of analysis methods. For example, [discounted cash flow](https://www.investopedia.com/terms/d/dcf.asp) (DCF) valuations, asset-based valuations, and multiples valuations using revenue, operating profit, or [profit margins](https://www.investopedia.com/terms/p/profitmargin.asp) are methods utilized to value a business segment.

## Insights Gained From the SOTP Valuation

Sum-of-the-parts valuation, or [breakup value](https://www.investopedia.com/terms/b/breakup-value.asp) analysis, helps a company understand its actual worth. For instance, a tech company might be "worth more than the sum of its parts," implying its divisions may be more valuable if sold separately.

In situations such as this one, larger companies have the ability to take advantage of the synergies and [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp) unavailable to smaller companies, enabling them to maximize a division's profitability and unlock unrealized value.

SOTP valuation is often used for companies with business units in various industries, as valuation methods differ by industry. This valuation can be used to fend off a hostile takeover by showing the company is more valuable when broken down into parts. This valuation can also be used when a company is revalued after [restructuring](https://www.investopedia.com/terms/r/restructuring.asp).

> **Important**
>
> The Sum-of-the-parts valuation is also known as the breakup value, as it assesses what individual segments would be worth if the company were broken up.

## Practical Example of Applying SOTP Valuation

Consider United Technologies (NYSE: UTX), which announced in 2018 that it would split into aerospace, elevator, and building systems units. Using the 10-year median [enterprise value-to-EBIT](https://www.investopedia.com/terms/e/ebit-ev-multiple.asp) (EV/EBIT) multiple for peers and 2019 operating profit projections, the aerospace business is valued at $107 billion, the elevator business at $36 billion, and the building systems business at $52 billion. Thus, the total value is $194 billion. Lessing out net debt and other items of $39 billion, the sum-of-the-parts valuation is $155 billion.

## Comparing SOTP Valuation with Discounted Cash Flow (DCF)

While both are valuation tools, the SOTP valuation can incorporate a discounted cash flow (DCF) valuation. That is, valuing a segment of a company may be done with a DCF analysis. Meanwhile, the DCF uses discounted future cash flows to value a business, project or segment. The present value of expected future cash flows is discounted using a [discount rate](https://www.investopedia.com/terms/d/discountrate.asp).

## Challenges and Limitations of SOTP Valuation

The sum-of-the-parts (SOTP) valuation involves valuing various business segments, and more valuations come with more inputs. As well, SOTP valuations do not take into account tax implications, notably the implications involved in a spinoff.

## Expanding Your Knowledge on SOTP Valuation

For help on choosing the right valuation tool check out [this guide to picking the right valuation method](https://www.investopedia.com/articles/fundamental-analysis/11/choosing-valuation-methods.asp).

## The Bottom Line

Sum-of-the-Parts Valuation (SOTP) is a robust method for assessing the value of companies with diverse business units across different industries. It calculates the value of each segment separately, combining them to determine the total enterprise value, adjusted by net debt, non-operating assets, and liabilities. This valuation is especially useful in scenarios involving conglomerates, hostile takeovers, or restructuring. However, SOTP involves various methodologies and inputs and may not factor in tax implications of spinoffs. Understanding SOTP can provide a more nuanced view of a company's actual value, empowering businesses and investors to make informed financial decisions.