Sum-of-the-Parts Modeling for Diversified Firms

Intermediate | Published: 2025-12-30

Sum-of-the-parts (SOTP) valuation breaks a diversified company into its individual business segments, values each separately using appropriate multiples, and sums the results. This matters because conglomerates and holding companies often trade at discounts to their component parts. Academic research finds conglomerate discounts averaging 10-15% of intrinsic value (Berger & Ofek, 1995). The practical point: SOTP identifies whether the discount represents a buying opportunity or reflects genuine value destruction from poor capital allocation.

When SOTP Is the Right Tool

Use SOTP when: You're analyzing companies with distinct business segments operating in different industries with different growth profiles, margins, and risk characteristics. A single multiple applied to consolidated earnings misrepresents value when segments deserve vastly different valuations.

The point is: If a company's technology division deserves 25x earnings and its industrial division deserves 12x, applying the blended 18x multiple undervalues the tech business and overvalues the industrial business. SOTP fixes this by valuing each appropriately.

Typical candidates for SOTP:

• Conglomerates (Berkshire Hathaway, 3M, Honeywell)
• Holding companies (IAC, Liberty Media, SoftBank)
• Diversified industrials (General Electric, Siemens)
• Media/telecom hybrids (AT&T pre-spinoff, Comcast)
• Companies with valuable minority stakes (stakes in public companies that can be marked to market)

Why this matters: Standard P/E or EV/EBITDA applied to consolidated financials produces misleading valuations for companies with segment mix shifts or hidden value in minority positions.

Step 1: Segment Identification from 10-K Disclosures

The SEC requires public companies to report segment-level financials under ASC 280. Find this in the 10-K under "Segment Information" or "Business Segments" (typically Note 15-20 in the footnotes).

Required disclosures you need:

• Segment revenues
• Segment operating income or EBIT
• Segment assets (for capital-intensive businesses)
• Geographic revenue breakdown

The durable lesson: Management defines segments strategically, sometimes to obscure poor performance. Cross-reference segment definitions against industry classifications. If "Corporate & Other" shows persistently large losses, that signals overhead allocation games or distressed operations hidden from view.

Practical extraction from 10-K:

1. Navigate to Item 8 (Financial Statements)
2. Find "Segment Reporting" footnote
3. Extract 3-year revenue and operating income by segment
4. Note any inter-segment eliminations or unallocated corporate costs

Step 2: Assigning Multiples to Each Segment

Each segment gets valued using multiples from pure-play comparable companies in that industry. This is where SOTP adds analytical value over consolidated multiples.

The calculation: Segment Value = Segment EBITDA (or EBIT or Revenue) x Peer Multiple

Multiple selection hierarchy:

1. EV/EBITDA for capital-intensive segments (manufacturing, telecom, utilities)
2. EV/EBIT when depreciation policies differ materially from peers
3. EV/Revenue for high-growth, pre-profit segments (software, biotech)
4. P/E for financial services segments (banks, insurance)

Example peer multiple research:

Why this matters: Using wrong multiples cascades into material valuation errors. A 2x multiple error on a $5B EBITDA segment creates $10B in valuation error.

Step 3: Corporate Overhead Allocation

Corporate headquarters costs (executive compensation, legal, shared services, real estate) must be deducted from the sum of segment values. These costs appear as "Corporate & Other" or "Unallocated Expenses" in segment disclosures.

Two methods:

Method 1: Direct deduction Capitalize corporate overhead at an appropriate multiple (typically 6-8x for G&A-type costs) and subtract from aggregate segment value.

Method 2: Pro-rata allocation Allocate corporate costs to segments based on revenue or asset weighting, then reduce each segment's operating income before applying multiples.

The practical antidote: Use Method 1 for transparency. If corporate overhead is $500M annually and you capitalize at 7x, subtract $3.5B from aggregate value. This makes overhead costs explicit rather than hiding them in reduced segment values.

Decision rule: If corporate overhead exceeds 3% of revenues, it warrants closer examination. Bloated overhead signals potential cost-cutting opportunity if an activist or acquirer takes control.

Step 4: The Conglomerate Discount

Markets typically apply a 10-15% discount to conglomerate valuations versus the sum of standalone segment values. This discount reflects real value destruction mechanisms.

Why the discount exists:

• Capital misallocation (cross-subsidizing weak segments with cash from strong segments)
• Management complexity (running unrelated businesses reduces focus)
• Opacity (harder for investors to evaluate individual segment performance)
• Dis-synergies (shared overhead that wouldn't exist in standalone entities)

The durable lesson: Don't assume the discount is always unjustified. Companies that consistently allocate capital poorly (overpaying for acquisitions, investing in low-ROIC segments) deserve the discount. Companies with disciplined capital allocation and clear segment reporting may trade at narrower discounts or even premiums.

When to reduce or eliminate the discount:

• Announced spinoffs or divestitures
• Activist investor involvement pushing for breakup
• History of value-creating capital allocation
• Clear segment reporting with minimal "Corporate & Other" costs

Worked Example: A Three-Segment Conglomerate

Hypothetical company: DiverseCo Inc.

You're valuing a company with three segments: Technology Solutions, Industrial Products, and Financial Services. Here's the segment data from the 10-K:

Segment financials (FY2024):

Corporate overhead: $400M annually (unallocated) Net debt: $8.0B Shares outstanding: 500M

Step-by-Step Valuation

Step 1: Assign peer multiples

Step 2: Calculate segment values

• Technology Solutions: $2.4B x 18x = $43.2B
• Industrial Products: $1.8B x 10x = $18.0B
• Financial Services: $0.9B x 10x = $9.0B
• Gross segment value: $70.2B

Step 3: Deduct corporate overhead

Corporate overhead capitalized: $400M x 7x = $2.8B

Adjusted segment value: $70.2B - $2.8B = $67.4B

Step 4: Apply conglomerate discount

Using 12% discount (midpoint of 10-15% range): $67.4B x (1 - 0.12) = $59.3B Enterprise Value

Step 5: Bridge to equity value

• Enterprise Value: $59.3B
• Less: Net debt: $8.0B
• Equity Value: $51.3B

Step 6: Per-share value

$51.3B / 500M shares = $102.60 per share

Sensitivity Analysis

The point is: Your valuation is highly sensitive to multiple selection and discount assumption.

Range: $78-136 per share depending on assumptions.

SOTP Modeling Checklist

Essential (high ROI)

These steps prevent major errors:

• Verify segment definitions match industry classifications (not management spin)
• Use at least 3 comparable companies per segment for multiple estimation
• Explicitly deduct corporate overhead (don't ignore it)
• Apply conglomerate discount unless clear catalyst for re-rating exists

High-impact (workflow)

For thorough analysis:

• Build sensitivity tables varying multiples by +/-2x per segment
• Test discount assumptions from 0% to 20%
• Cross-check against market cap (does SOTP explain current trading level?)
• Identify any minority stakes or investments to add separately

Optional (for activist-style analysis)

If evaluating breakup potential:

• Estimate standalone cost structures for each segment
• Quantify dis-synergies (what costs would increase post-spinoff)
• Model timeline and tax leakage from potential separation

Common Pitfalls

1. Using consolidated multiples for segment peers If your Technology Solutions segment has 30% margins and you use a peer with 15% margins, the multiple comparison is flawed. Match on growth rate and margin profile, not just industry.

2. Ignoring inter-segment revenues Some segments report sales to other segments. These eliminate in consolidation. Don't double-count by using gross segment revenues without adjusting for inter-segment sales.

3. Forgetting to mark minority stakes to market Public company stakes should be valued at market price, not book value. A 10% stake in a $50B company is worth $5B regardless of what the balance sheet says.

4. Zero conglomerate discount on "good" companies Even well-managed conglomerates face complexity discounts. Start with 10% and justify reductions with specific evidence.

Next Step

Identify a conglomerate in your portfolio or watchlist. Pull the 10-K and extract segment-level revenue and EBITDA. Find 2-3 pure-play comparables for each segment and note their EV/EBITDA multiples. Calculate SOTP value with a 12% conglomerate discount. Compare to current market cap. If SOTP value exceeds market cap by more than 20%, investigate whether there's a catalyst (activist involvement, announced spinoff, management change) that could close the gap.

Related Articles

• Comparable Company Analysis Step by Step
• Evaluating Management Incentives and Ownership
• Assessing Capital Allocation Track Records

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References

Berger, P. G., & Ofek, E. (1995). Diversification's effect on firm value. Journal of Financial Economics, 37(1), 39-65. Documents average conglomerate discount of 13-15%.

Koller, T., Goedhart, M., & Wessels, D. (2020). Valuation: Measuring and Managing the Value of Companies, 7th Edition. Wiley. Chapter 14 (Multibusiness Valuation).

SEC ASC 280. Segment Reporting. Codification Topic 280 for segment disclosure requirements.