Sum-Of-Parts Valuation

Categories: Company Valuation

The stock was trading for $70. It had 3 divisions. As stand-alones, they were worth $25 a share, $40 a share, and $15 a share. The sum of their parts as noted was that, broken up, the company was worth $80. Why did the company then trade for only $70?

Well, there are a number of reasons, but in large part it was the CEO, who was politically extreme. She made her politics known and alienated half the country. So that half simply didn't want to own her shares and deal with her politics.

A banker went through the first division, which was a dog, trading at 10x $2.50, and explained how, just taking that one piece out of the holding company would add 5 bucks in value to the stock. But, unit by unit, it became clear that the company should be split up to force Wall Street to recognize the value of the company in its three parts, and if it didn't, then others (private equity risk-takers) likely would...and pay a big premium to own one of the 3 main divisions.

They could do all that via a sum-of-parts valuation, i.e. just fire the CEO and replace her with someone who kept their politics to themselves, and just ran a good company.

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Finance: What are Valuation Analysis, Fo...4 Views

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Finance Allah shmoop What are valuation analysis formats and ratios

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It's a thing dot com It sells Who's ima wa

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s Okay but investors want to know what percentage of

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the company there ten million bucks will buy So somebody

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has to know what it's worth and why There has

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to be some exercise here which delivers an actual number

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that says at this moment it's a thing dot com

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is worth X Well in real life the most sophisticated

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valuation format lives in applying a discounted cash flow analysis

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model Yeah go watch are most excellent video directed by

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Martin Scorsese on that topic If you haven't seen it

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it won the Golden Mullah Award back in two thousand

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eighteen Well if you haven't seen it the notion is

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that company's heir valued as a stream of their cash

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profits like into the future Cash profits Five million next

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year Ten million The next eighteen million accents sold for

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one hundred million the next Then all those cash flows

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or discounted back or divided by one plus the risk

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free rate I'ii uh you know the rent You could

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get on your cash just by investing in U S

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Government bonds plus risk Got it So that is risk

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that the ten million of cash profits doesn't in fact

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happen in real life like you're taking more risk than

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you are investing in government bonds when you invest in

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equities like this right So if the risk free rate

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is in a three percent like a five year T

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Bill or something like that then you might pile risk

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on top of that of saying six percent or ten

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percent or twenty percent a year And the certainty of

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that ten million box in profits in two years changes

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a lot and then that hundred million at the very

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end Well it might have huge discounting like be divided

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by one plus the risk free rate plus a huge

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risk premium act on in the denominator making one hundred

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million a very small number like it's very risky So

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maybe that discount rate ends up being I don't know

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say thirty percent added to the risk free rate and

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it's four years out So it's taken to the fourth

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power Yeah a lot of discounting that it looks like

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this You got one point Oh three plus point three

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Oh it's one point three three then to the fourth

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power that you're going to divide into one hundred million

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and give that a huge haircut But okay okay this

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is a sophisticated Wall Street e way of valuing companies

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There are simpler methods Multiples of sales is another one

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that while people use And yes of course we have

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an entire video on that one as well A company

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has highly volatile profits like this is kind of company

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that would use a multiple of sales valuation positive twenty

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percent margins in great times negative fifteen percent margins in

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bad times and an average over a decade of statement

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of ten percent margins So on five hundred million of

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sales it might on average have fifty million in net

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profits and the average grows over time But the company

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quote should unquote trade at a market multiple minus two

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turns or something like that Or set another way if

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the S and P five hundred straining at sixteen times

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earnings well then maybe this crappy company that's highly cyclical

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should trade it fourteen times Well fourteen times fifty is

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seven hundred and note that that's about one point four

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times sales Wealthy calculation then revolve around sales instead of

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profits usually since year after year profits are yeah all

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over the place where sales are relatively steady like they'll

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go up three percent in Goodyear and down to percent

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of badly or something like that So that's a multiple

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of sales valuation format It's often used for early stage

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companies who really don't have profits and would reinvest all

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their free profits or cash into growth anyway So you

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can imagine the same system applying to things like multiples

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of gross margin for multiples of operating margin like pre

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tax profits With the basic idea being that the closer

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you get to the top line sales number usually the

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less volatile those numbers on a year in year out

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basis are and then the easier the valuation remains to

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dial in structurally well cash flow multiples are good delimit

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er zzzz Well think about how quote phantom depreciation unquote

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works in clouding the true earnings Pictures of things like

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a factory that cost a billion bucks to build and

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is being depreciated to zero over ten years might carry

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an earnings hit to the income statement of well a

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hundred million bucks a year in straight line appreciation It

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takes the eighty million in profits the company is making

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toe being an accounting loss of twenty million dollars So

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how does that work Well you thought you were making

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eighty million in net profits but it turns out you've

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got to depreciate one hundred million for that factory You

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lavished Tobi right Well the cash the company produces is

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its cash flow like from progressive Yet you know her

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and backing out that appreciation gives a much clearer picture

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of the company's expected profit ability in the future i

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e Its value meaning you pay a whole lot more

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attention to that eighty million dollars in profits Then you

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do the twenty million in losses But this valuation method

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becomes extremely useful in cases where that factory being appreciated

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to zero in ten years will in fact last more

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like forty years and even then not be worth zero

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So we have discounted cash flow We have multiple of

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sales We have multiple of cash flow And then of

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course the stalwart multiple of earnings or price to earnings

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ratio as a basic valuation format or racial or structure

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that drives the lives of oh so many investments P

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ratios are probably the most common evaluation metric Whatever dot

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com will earn after everything appreciation included a dollar next

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year a dollar twenty the following year and a dollar

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forty the next It trades this moment for twenty bucks

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a share or twenty times this year's earnings That's twenty

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over one point two times next year's earnings twenty over

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one point four times at the following years And yet

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you get the picture It looks like that Well the

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price to earnings multiple usually goes down over time because

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well most companies actually grow their earnings over time The

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Gatun here is that companies often carry cash and or

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debt So if a company has ten dollars a share

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in debt and four dollars a share in cash well

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then its price to earnings ratio is while still twenty

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But it likely has Mohr volatilities in its movements as

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the debt is well kind of like gasoline on a

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fire when things go well or poorly So yeah those

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were the most common methods of assessing the value of

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a company or a stock and you've got to take

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all of them with many grains assault Although uh well

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It's much easier if you just have one of these 00:06:07.671 --> [endTime] things to assess

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