(Via Greg Mankiw)
In an article in WSJ Jeremey Siegel points to possible problems with the way S&P calculates P/E ratios. He later responds to critics in an article on Yahoo, in which makes an interesting point about "the sum of stock prices of 500 stocks must be worth more than "a single company with 500 divisions,". The logic here being losses cross boundaries within divisions with shareholders sharing combined losses, while in case of seperate companies, bondholders bear the losses. Since as per option theory "The value of a firm's equity can be viewed as an option on the total value of the firm, after the bondholders and other claimants have been paid. It is a fundamental theorem of option theory that the sum of the option prices on individual firms is worth more than a single option on the value of all the firms."
Taking the logic forward, what does that say about the value a company with multiple divisions...as per above it would depend on whether the management cross-subsidizes losses across divisions or if it sells of loss-making divisions at the value of the option the division represents. So greater the diversification among divisions lower the value or higher the conglomerate discount, unless the conglomerate is run strictly as a portfolio with high correlation among divisions.
Cycling back Jeremey Siegel's argument would depend on the correlation between the 500 components of S&P 500. So if you believe S&P 500 companies offer significant diversification, lesser the reason why you should treat it as "company with 500 divisions".