Authors: Grigoria Chlomou, Efthimios Demirakos

Title: How Do Financial Analysts Implement the Sum-of-the-Parts Valuation Framework?

Abstract

In this study, we investigate how financial analysts actually implement the Sum-of-the-Parts (SOTP) valuation framework. Although SOTP constitutes a popular valuation approach among sophisticated practitioners and investors, it is mostly ignored by researchers and academics.  We adopt a structured content analysis of 265 equity research reports written by 33 investment brokerage houses for 140 UK-based firms.  We find that analysts typically use EBITDA multiples to implement SOTP.  We also show that analysts usually identify more segments in their SOTP analysis compared to the reportable segments in the firms’ annual reports based on IFRS 8. Furthermore, financial analysts are more likely to consider SOTP the dominant or preferred valuation model in their report.  Finally, although SOTP seems theoretically ideal to estimate the value of a multi-segment firm, we do not find empirical evidence to support the hypothesis that SOTP significantly outperforms a full-blown Discounted Cash Flow (DCF) model, when the latter is used separately to value the company as a whole.