Accretion / Dilution
Whether an acquisition increases (accretive) or decreases (dilutive) the acquirer’s earnings per share. A standard merger-model output and a common technical interview topic.
Accretion / Dilution · the mechanism
1 min read
Call a deal accretive or dilutive before you open a model, and say why that is a weak test.
Where it comes up. An MD on the phone to a client asks whether the deal is accretive. You have the two multiples and about ten seconds.
All-stock: compare the multiples
If the acquirer’s P/E is higher than the P/E it is paying for the target after the premium, the deal is accretive. Expensive paper buying cheap earnings adds to earnings per share. That is the whole shortcut, and it is what an interviewer expects in seconds rather than minutes.
Cash or debt: compare yields
Put the target’s earnings yield, which is one over its P/E, against the after-tax cost of the funding. Debt at 6% with 25% tax costs 4.5%; a target at 12x has an 8.3% earnings yield, so it is accretive by a wide margin.
Then say what it does not tell you
Accretion is arithmetic about relative multiples and funding, not evidence of value creation. A company can buy a declining business with cheap earnings, print accretion in year one, and have destroyed value. The tests that matter are return on invested capital against cost of capital, whether the synergies are real, and whether it can be integrated.
Worked through
Acquirer at 20x buying a target at 10x, all stock, no premium and no synergies.
- Acquirer earnings yield
- 1 ÷ 20 = 5.0%
- Target earnings yield
- 1 ÷ 10 = 10.0%
- Effect
- Buying 10% earnings with 5% paper
- Break-even premium
- Roughly 100%, at which the target reaches 20x
Accretive, and it stays accretive until the premium takes the target multiple up to the acquirer’s own. That break-even premium is the follow-up, and knowing it comes from setting the two multiples equal is what makes the answer sound like understanding rather than a rule.
Check yourselfA cash deal funded from the balance sheet is almost always accretive. Why is that not impressive?
Answer once you have one →
Because the cost of that funding is only the after-tax interest income given up, which is close to nothing when rates are low. Almost any earning asset clears that bar. The arithmetic says accretive while telling you nothing about whether the price was sensible, which is precisely why accretion is a screening test rather than a verdict.
Be able to say this back next week
- Compared P/E ratios for stock, and earnings yield against after-tax funding cost for cash
- Volunteered that it is before synergies and before the financing mix
- Said accretion is arithmetic, not evidence of value creation
Why Accretion / Dilution matters in interviews
Accretion/dilution is the first question a public-company board asks about a deal, so it is the first question a banking interviewer asks about merger models. It is also a rare technical with a clean shortcut, which is exactly why interviewers like it — they can watch you reach for the shortcut or grind through the model.
How it works in practice
A deal is accretive if the acquirer's pro-forma earnings per share rises, dilutive if it falls. You build it by combining the two companies' net income, adding after-tax synergies, subtracting after-tax incremental interest on any acquisition debt and any foregone interest on cash used, then dividing by the new share count including shares issued as consideration.
The shortcut for an all-stock deal: compare the P/E ratios. If the acquirer's P/E is higher than the target's effective P/E (purchase price / target net income), the deal is accretive. Acquiring a cheaper company with expensive paper adds to EPS.
For cash and debt consideration, compare the after-tax cost of the funding to the target's earnings yield (the inverse of its P/E). Debt at 6% pre-tax and a 25% tax rate costs 4.5% after tax; if the target is bought at 15x, its earnings yield is 6.7%, so the deal is accretive.
What candidates get wrong
- Forgetting to tax-affect the incremental interest expense and the synergies.
- Ignoring foregone interest income when cash on the balance sheet funds the deal.
- Treating accretion as a proxy for value creation. A deal can be accretive to EPS and still destroy value if the acquirer overpaid — the two questions are separate, and good interviewers will push you on it.
- Omitting incremental D&A from the write-up of acquired intangible assets in purchase accounting.
Accretion / Dilution: frequently asked questions
Is an accretive deal always a good deal?
No. Accretion measures the direction of pro-forma EPS, not whether value was created. An acquirer with a high P/E can buy almost any lower-multiple business and report accretion while still paying more than the target is worth. Value creation depends on whether the price paid is below the present value of the cash flows plus synergies acquired.
What is the quick way to tell if an all-stock deal is accretive?
Compare P/E multiples. If the acquirer trades at a higher P/E than the multiple it is paying for the target, the deal is accretive to EPS. If it pays a higher multiple than its own, it is dilutive. This holds before synergies and transaction adjustments.
Practise it
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