Conglomerate discount isn’t what its name may suggest. It’s a drawback for a conglomerate with multiple sections/divisions/companies, all of which aren’t generally successfully run as a cohesive unit. As a result, the market may discount the value of a multi-division corporation, giving less value to its earnings.
Calculating the Conglomerate Discount
As mentioned above, a conglomerate discount isn’t a good or popular thing among most market analysts. It occurs within the economy primarily as a way to keep conglomerate companies in check.
Perhaps the simplest way to understand a conglomerate discount is to understand how it is calculated. It is a discounted valuation of the stocks associated with all of the divisions/subsidiary companies within a conglomerate.
Valuation is determined by adding together the intrinsic value of all the smaller companies within a conglomerate, then subtracting the market capitalization for the conglomerate. It typically results in a 10%-15% discount in valuation for the conglomerate.
The calculation is particularly harsh on the largest conglomerates because their market capitalization is the highest. In this way, the conglomerate discount doesn’t account for or discounts the true value of each piece of the conglomerate by lumping the value of each together and cutting out a huge value chunk by subtracting the conglomerate’s market cap.
Conglomerate Discounts Aren’t Permanent
In most cases, a conglomerate will face a discount at least once during its existence; however, most conglomerates don’t function under the discount indefinitely. It is due to the diversification inherent in the formation of conglomerates. Most are established in order to help a company – that is, the parent company – boost profits and revenue, and improve their bottom line in times of difficulties or financial failures.
The formation of a conglomerate is widely viewed as the process by which a less successful or failing firm diversifies itself in order to improve its earnings and become stronger and more successful.
Usually, after the completion of the diversification process, the market places a conglomerate discount on the business, working to keep it in check. In certain instances, a conglomerate may operate under a discount for years. In other situations, conglomerates such as Berkshire Hathaway operate at a conglomerate premium for many years.
A conglomerate premium is, essentially, the exact opposite of a conglomerate discount. As is true in Berkshire Hathaway’s case, the conglomerate’s many divisions and subsidiaries get their intrinsic value combined and the parent company’s market cap is added, giving substantially more value to each piece of the conglomerate and to the conglomerate as a whole.
Not all conglomerates face a conglomerate discount, though most experience some devaluing of the parts of their empire as a response from the market. In the event that the conglomerate is managed effectively and turns a consistent profit, the market generally begins to favor the conglomerate, enabling its stock to be valued at a premium.
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