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SOTP Valuation
Sum of the Parts (SOTP) valuation is a method used in Equity Research to determine the fair value of a company by breaking it down into its individual business segments and valuing each segment separately.
SOTP valuation assumes that a company is worth more than the sum of its parts, i.e., the value of each business segment is higher when it is analyzed individually than when it is combined with the other segments.
To conduct a SOTP valuation, Equity Research analysts typically identify the different business segments of the company and assign a separate valuation to each segment based on its financial performance, growth prospects, and other relevant factors. The valuation of each segment is typically based on an appropriate valuation method, such as discounted cash flow (DCF) analysis, price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, or enterprise value-to-EBITDA (EV/EBITDA) ratio.
Once the valuation of each segment is completed, the Equity Research analyst adds up the valuations to arrive at the SOTP valuation of the company. The SOTP valuation provides a more accurate estimate of the company’s value, as it takes into account the unique characteristics and prospects of each business segment.
SOTP valuation is particularly useful for companies with diverse business segments, as it helps investors understand the relative contribution of each segment to the company’s overall value. It is also useful for companies that are considering divestitures or spin-offs, as it provides a framework for assessing the potential value of each business segment if it were to be sold or spun off as a separate entity.
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