Financial Modeling Self Study Program

If a company with a low P/E acquires a company with a high P/E in an all stock deal, will the deal likely be accretive or dilutive?

Other things being equal, if the Price to Earnings ratio (P/E) of the acquiring company is lower than the P/E of the target, then the deal will be dilutive to the acquiror’s Earnings Per Share (EPS).  This is because the acquiror has to pay more for each dollar of earnings than the market values its own earnings.  Hence, the acquiror will have to issue proportionally more shares in the transaction.  Mechanically, proforma earnings, which equals the acquiror’s earnings plus the target’s earnings (the numerator in EPS) will increase less than the proforma share count (the denominator), causing EPS to decline.

Comments are closed.