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

Chlomou, Grigoria; Demirakos, Efthimios

doi:10.1016/j.irfa.2020.101514

Cited by 10 publications

(15 citation statements)

References 38 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…Using univariate analyses, they fail to provide evidence that the SOTP valuation significantly outperform the DCF calculation, when the latter is used to value the company as a whole. However, Chlomou and Demirakos (2020) also suggest that in a sample of equity research reports written by 4 and 5 star analysts, which is based on Thomson Reuters Eikon methodology of analysts' rankings, the popularity of SOTP increases to 26.46%. Paarz (2011) investigates 2779 analyst reports of 249 German publicly listed firms from 1998 to 2007 and contrary note that only about 26% of the target prices base on a SOTP calculation.…”

Section: Literature Reviewmentioning

confidence: 99%

“…Thus, it is also worth investigating whether analysts apply a holistic or a SOTP approach to determine the fundamental value of the company, and how the performance of these approaches differs in terms of target price accuracy. As Chlomou and Demirakos (2020) already note, the SOTP valuation framework has been mostly ignored by researchers and academics, although it represents a popular approach among sophisticated practitioners. In particular, the accuracy of company valuations derived from SOTP compared to a holistic valuation has not yet been sufficiently investigated.…”

Section: Literature Reviewmentioning

confidence: 99%

“…In particular, the accuracy of company valuations derived from SOTP compared to a holistic valuation has not yet been sufficiently investigated. Chlomou and Demirakos (2020) analyze the content of 265 equity research reports for 140 UK-based firms to investigate how analysts implement the SOTP valuation approach and how it differs from holistic valuations in target price accuracy. They note that in about 70% or 185 of the analyzed reports the analysts use the SOTP approach as preferred model rather than a DCF calculation as stand-alone model.…”

Section: Literature Reviewmentioning

confidence: 99%

“…Analysts are also sensitive to segmental disclosures and frequently refer to this information in their reports (Demerens et al 2017). However, previous research on whether analysts actually value the company by its parts or as stand-alone entity is limited and shows inconsistent results (Chlomou and Demirakos 2020;Demerens et al 2017;Paarz 2011). Arguably, the list of possible methods and modifications that financial analysts may use in practice is very long (for examples see Imam et al 2013).…”

Section: Introductionmentioning

confidence: 99%

“…Second, we shed light on whether analysts prefer to use SOTP or holistic approaches to value a company. Like hybrid approaches, the SOTP valuation has been mostly ignored by researchers and academics, although it is widely used in practice (Chlomou and Demirakos 2020). Third, we analyze the performance of each approach in terms of target price accuracy and investigate whether certain approaches are better suited to estimate price targets.…”

Section: Introductionmentioning

confidence: 99%

See 4 more Smart Citations

How valuation approach choice affects financial analysts’ target price accuracy

Erkilet

Janke²,

Kasperzak

2021

J Bus Econ

View full text Add to dashboard Cite

This paper examines which valuation approaches financial analysts use to value a company and whether the chosen valuation approach affects the target price accuracy. To address these questions, we conduct content analyses of 867 hand-collected analyst reports on German publicly listed companies published between January 2014 and June 2017. We find that sell-side analysts more frequently use the single-period market approach when formulating target prices, followed by the multi-period income approach, and a mixture of both by combining the results, the so-called hybrid valuation approach. Additionally, we show that 612 of the analyzed analyst reports are based on a holistic valuation methodology instead of a sum of the parts valuation technique. Both univariate and multivariate analyses emphasize that the choice of valuation approach is significantly associated with the accuracy of price targets. Specifically, the income and market approach lead to significantly more accurate target prices compared to the hybrid approach. We also find that the target price accuracy is higher when analysts apply the holistic rather than the sum of the parts valuation approach to determine the fundamental value of the company. Additional results emphasize that target price accuracy improves when analysts use the sum of the parts valuation that bases solely on market or income approaches rather than hybrid approaches. Hence, we contribute to theory and practice by providing evidence on the link between the choice of valuation approach and the analysts’ target price accuracy as well as on the performance of certain valuation techniques.

show abstract

Section: Literature Reviewmentioning

confidence: 99%

Section: Literature Reviewmentioning

confidence: 99%

Section: Literature Reviewmentioning

confidence: 99%