Accretion/dilution analysis measures the effect of an acquisition on the acquirer's earnings per share (EPS). A deal is accretive if the acquirer's pro forma (post-deal) EPS is higher than its standalone EPS, and dilutive if it is lower. It is a standard first screen of a deal's financial impact, especially for public acquirers sensitive to EPS.

How it is calculated

  1. Combine the net incomes of acquirer and target.
  2. Add after-tax synergies expected from the combination.
  3. Subtract the after-tax cost of financing — new interest on debt raised, and/or foregone interest on cash used.
  4. Adjust the share count — if the buyer issues new shares as consideration, the denominator rises.
  5. Compute pro forma EPS = pro forma net income ÷ pro forma shares, and compare to standalone EPS.

Rules of thumb

  • Stock-for-stock deals: broadly, the deal is accretive when the acquirer's P/E is higher than the target's (effectively, the acquirer's P/E versus the P/E it pays for the target). A higher-multiple buyer purchasing a lower-multiple target tends to add EPS.
  • Cash- or debt-financed deals: broadly accretive when the target's after-tax earnings yield exceeds the after-tax cost of the financing used.

Accretion is not value creation

A crucial caveat taught in every M&A course: accretion does not mean the deal creates value, and dilution does not mean it destroys value. Because cheap debt and P/E differences can mechanically boost near-term EPS, a deal can be accretive yet still be a poor use of capital if the price overpays for the target's cash flows. Sound analysis pairs accretion/dilution with a fundamental DCF and valuation view.

See also

  • Business valuation — The set of methods used to estimate the economic value of a company or its equity.
  • Synergy — The extra value a combined company can create beyond the sum of the two firms apart.
  • Discounted cash flow — An intrinsic valuation that discounts a company’s projected cash flows to present value.
  • Leveraged buyout — An acquisition financed largely with borrowed money, repaid from the target’s cash flows.

References & further reading

  1. Corporate Finance Institute — “Accretion Dilution Analysis”
  2. Wall Street Prep — “Accretion / Dilution Analysis”
  3. Investopedia — “Accretive”
Category: Valuation