Getting to grips with different company valuation measures: The ins and outs of the ‘sum of the parts valuation’

Julie Brownlee, Fsp Invest, 11 Sep. 2014

Tags: sum of the parts valuation, what is sum of the parts valuation, valuing companies, valuation, valuation measures

If you read any analyst write-ups or more in-depth financial articles on a company, you may come across the term ‘sum of the parts valuation’.

So exactly what is a sum of the parts valuation? And what can it tell you?

Let’s take a closer look…

What makes up a company’s valuation?

Many companies have a number of different underlying businesses under its umbrella. The profits of these different businesses give the company its overall profits.

With companies like this, trying to value it with measures such as the price earnings (PE) ratio can be a bit misleading.

That’s because certain businesses within the company may perform much better than other businesses. And one or more of those underlying businesses can have a much bigger influence on the overall performance of a company than others.

This means that a company’s share can look more expensive or cheaper than it really is.

For example, one of the businesses within a large company may be relatively insignificant to the overall profitability of the company. But in the hands of a different owner, the business could be worth a lot more.

This is where the sum of the parts valuation comes in

To deal with this, sometimes analysts will value each of a company’s underlying businesses separately. They may do this looking at measures, such as its profitability and assets.

The analyst then adds up all of the different valuations of each of the businesses and deducts liabilities, for example debt, to come up with a total estimated value of the company. And this is the sum of the parts valuation.

The sum of the parts valuation can be a good way of spotting bargains or firms that could be broken up.

So there you have it, the ins and outs of the sum of parts valuation.

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