Of all the ways to value a stock, one method is unlike the others. Sum of the parts (SOTP) valuation splits up the company into its divisions and values each one separately. Investors with financial advisors that invest in large companies may benefit from having a working knowledge of the technique.
SOTP Investing
The SOTP value, or breakup value, is the sum of each segment’s valuation, adding net debt and non-operating assets, subtracting non-operating liabilities. Non-operating assets and liabilities refer to those not used in daily operations.
The idea is to focus on each division as if it were to be spun off or acquired by another company. This helps the investor consider financial intricacies that may otherwise remain obscured with broader valuation models. If a firm’s breakup value is continually greater than its total market value, shareholders may push for a spinoff.
Application
This SOTP technique is especially useful for large conglomerate companies since they compete in different industries. For such companies, each segment is a puzzle piece that can significantly contribute – or hinder – overall profitability and success. In strategic thought, SOTP can also identify those divisions with the greatest potential or less certain outlooks.
Limitations
While the breakup value considers what most models don’t, it still does not consider implications involved with a spinoff, such as tax consequences. Critics also argue it oversimplifies the interdependencies between each segment that contribute to each one’s value. Finally, SOTP is a difficult endeavor to do alone, as it requires thorough and accurate knowledge of each division individually.
Starting a Customized Portfolio
For investors looking to diversify their holdings with those large equities, First State tailors client portfolios with Gold Chip stocks and broad market sectors. For a free consultation with Tulsa financial advisors, contact us at 918-492-1361.
This overview is for informational purposes only and is not a recommendation. It should not be the sole deciding factor in making an investment. Investing is a risk and, as with all risks, a positive return is not guaranteed. Past performance does not indicate future results.