Sum-of-the-parts

Some companies are not one business. ITC and L&T, the workbook's own examples, run several unrelated businesses under one listed umbrella. Applying a single P/E to the group treats a hotel chain and a cigarette business as though they deserve the same rating, which they plainly do not.

Sum-of-the-parts fixes that by refusing to blend. Value each vertical as if it were an independent listed company, using whatever earnings or asset method suits it, then add the pieces up.

The workbook's method is deliberately simple: each business vertical is treated as an independent business and valued as described elsewhere in the chapter, based on earnings and assets; then simple summation gives the value of the total business.

The discipline is in choosing the right measure for each part. A capital-intensive segment with old plant is valued on EV/EBITDA rather than EV/EBIT, because depreciation policy distorts the comparison. A segment that has only just broken even is valued on EV/Sales, because the profit multiple would be absurdly high. An asset-heavy segment such as real estate may be valued on net asset value.

What comes out of the summation is a set of enterprise values. Net debt is subtracted once, at the group level, to get to equity.

SOTP equity value = Σ (segment enterprise values)
                    − net debt
                    − unallocated corporate costs capitalised

Per share = SOTP equity value ÷ shares outstanding

A diversified group with five reported segments:

Less net debt                      4,000
Equity value                   3,48,600 crore
On 1,250 crore shares            Rs 279 per share

Now do it the lazy way. Group EBITDA, adding the FMCG segment's Rs 1,500 crore, is Rs 24,400 crore. Apply the cigarette business's 12× to the whole group:

24,400 × 12 = Rs 2,92,800 crore

That is Rs 59,800 crore — 17% — below the sum of the parts, because a hotel business the market rates at 18× and an FMCG business worth more than its thin EBITDA suggests have both been dragged down to the tobacco multiple. On 1,250 crore shares the blended approach says Rs 231 a share against Rs 279. Same company, same accounts, Rs 48 a share of difference created purely by refusing to look at the parts.

Chapter 10 (section 10.10) covers SOTP directly, naming ITC and L&T as the kind of company it suits. The examinable point is the method itself — value each vertical independently on earnings or assets, then add — and recognising from a description that a multi-business group is the case where a single multiple fails.

• Subtract net debt once, at the group level. Taking it out inside each segment and again at the top double-counts it and badly understates the equity value.
• Segment disclosure is the binding constraint. If the annual report does not report segment EBITDA, the parts cannot be valued separately and SOTP becomes guesswork.
• Unallocated corporate costs sit outside the segments. The holding company's own overhead is real and ignoring it overstates the total.
• The workbook applies a simple summation and no holding company discount (Chapter 10.10). In practice listed conglomerates often trade below their SOTP; the workbook does not teach a discount, so do not add one in an exam answer.
• The heading says SOTP and the text says "Sum-Of- Parts (SOP)". They are the same method; both spellings appear in Chapter 10.
• SOTP does not create value. It reveals a gap between the group's price and its parts. Closing that gap needs a demerger or a sale, and neither is in the analyst's gift.