P/E of A is 10x. P/E of B is 20x. If A acquires B, is it accretive or dilutive?
The deal is dilutive to A's EPS because in an all-stock deal, a lower-P/E buyer (10x) acquiring a higher-P/E target (20x) must issue proportionally more shares than the earnings gained.
Intuition
A's stock is 'cheap' relative to its earnings (low P/E), meaning each share of A represents a lot of earnings power. When A issues its cheap, earnings-rich shares to buy B's expensive, earnings-poor shares, A is trading high-earning currency for low-earning assets. The combined entity's earnings per share must fall because A diluted its concentrated earnings across shares that brought in proportionally less earnings.
Watch
The interviewer may follow up: 'How could A make this accretive?' Answer: by using cash or debt instead of stock, or by realizing synergies. With cash/debt, A avoids issuing expensive (in earnings terms) shares. Also, this entire analysis assumes an all-stock deal — always state that assumption explicitly.
Deep Dive
Determine whether A acquiring B in an all-stock deal is accretive or dilutive to A's EPS, given their respective P/E multiples.
Assumption: All-stock deal (the default when only P/E ratios are given and no financing is specified).
Step 1: Translate P/E into earnings yield
| Company | P/E | Earnings Yield |
|---|---|---|
| A (buyer) | 10x | |
| B (target) | 20x |
Step 2: Core logic
In an all-stock deal, A issues its own shares (which "cost" it an earnings yield of 10%) to buy B's earnings (which yield only 5%). A is paying a higher price per dollar of earnings than what its own shares generate.
Concretely: every $1 of B's earnings costs A $20 of equity value (B's P/E of 20x). But A's shareholders value each $1 of A's earnings at only $10 (A's P/E of 10x). So A must issue $20 of its stock — representing $2 of A's earnings power — to buy just $1 of B's earnings.
Step 3: Illustrative proof
- A: Share price = $10, EPS = $1.00, Shares = 100 → Net Income = $100, Market Cap = $1,000
- B: Share price = $20, EPS = $1.00, Shares = 100 → Net Income = $100, Market Cap = $2,000
A pays B's market cap in stock: new shares issued.
A's standalone EPS was $1.00 → Pro forma EPS is $0.667 → Dilutive (EPS fell by 33%).
Answer: The deal is dilutive to A's EPS.
Shortcut: In an all-stock deal, if the buyer's P/E is lower than the target's P/E, the deal is always dilutive. The buyer is using its "cheap" (low-multiple) currency to purchase "expensive" (high-multiple) earnings. Higher P/E buys lower P/E → accretive. Lower P/E buys higher P/E → dilutive.