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How do financial analysts implement the Sum-of-the-Parts (SOTP) valuation framework?

Chlomou, Grigoria; Demirakos, Efthimios


Efthimios Demirakos


In this study, we investigate how financial analysts implement the Sum-of-the-Parts (SOTP) valuation frame-work. 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. Furthermore, financial analysts are more likely to consider SOTP the dominant or preferred valuation model in their report. We show that managers disclose a greater quantity of segmental information if their firms are considered difficult to analyze and value by investors and creditors, thereby decreasing the information asymmetry with their capital providers. In specific circumstances, we document that financial analysts identify more segments in their SOTP analysis compared to the reportable segments in the firms' annual reports based on IFRS 8. We argue that the financial analysts' choice to employ a greater number of segments in their SOTP models might be primarily driven by their effort to support their reports' optimistic target prices. 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.

Journal Article Type Article
Acceptance Date Mar 27, 2020
Online Publication Date May 14, 2020
Publication Date 2020-07
Deposit Date Sep 5, 2022
Journal International Review of Financial Analysis
Print ISSN 1057-5219
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 70
Article Number 101514
Keywords Sum-0f-the-Parts (SOTP), Valuation Models, Financial Analysts, Equity Research Reports, IFRS 8
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