One of the common ways for analysts to determine the valuation of large conglomerates is to estimate a value for each different division within a company and then add up the values to get a total. This approach is called “sum-of-parts” valuation. A company’s sum-of-parts valuation is an approximation of what a company would be worth if it were broken up and each of its divisions were spun off.
There is no simple formula or equation for determining sum-of-parts valuation, because valuation methods differ depending on the industry or the division. However, generally speaking, the formula below is a typical approach.
- Equity value = (value of segment A) + (value of segment B) + … + (value of segment N) – (net debt) – (nonoperating liabilities) + (nonoperating assets)
The more complex a conglomerate is, the more useful a sum-of-parts valuation can be. For example, General Electric Company
A GE sum-of-parts valuation would be extremely complex, so here’s a much simpler example. Wal-Mart Stores, Inc.
In Wal-Mart’s most recent annual report, the company disclosed the following sales figures for each of its segments:
- Wal-Mart Stores: $298.3 billion.
- Sam’s Club: $56.8 billion.
- International: $123.4 billion.
If you use price/sales ratio as the valuation metric of choice, you can assign different multiples to each segment and then add up the values of each.
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- Wal-Mart Stores: ~$54/share.
- Sam’s Club: ~$16/share.
- International: ~$7/share.
So, using this particular sum-of-parts method, you get a total value for Wal-Mart stock of $54 + $16 + $7 = $77/share.
This is just a very crude example, but if you were confident in your valuation method, that $77 would potentially be your price target for Wal-Mart.
When a company runs different divisions that focus on different businesses, applying the same valuation method for the entire company is not typically the best approach. Instead, consider using a sum-of-parts approach to assigning an appropriate value to each division of the company.
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