Accretion and dilution
Also known as: EPS impact, Accretion analysis
Whether the buyer's earnings per share go up or down. Not a valuation, and the number a board will actually ask about.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat actually happens?
When a company buys another, its shareholders want to know one thing before anything else: will my share of the profits go up or down?
The arithmetic is simple. Add the two companies' profits together. Subtract whatever the purchase costs — interest on money borrowed, or interest given up on cash spent. Then divide by the number of shares, which has grown if the buyer paid in shares. If the result is higher than before, the deal is accretive. If lower, dilutive.
Boards ask about this constantly and it is not a valuation. It says nothing about whether the price was right or whether the businesses fit together. A company can pay far too much and still show higher earnings per share, and it can pay a sensible price and show lower ones.
The reason is that the answer depends mostly on a comparison of multiples. If the buyer is valued at twenty times its profits and buys something at twelve times, it is buying profits more cheaply than its own are valued — and its earnings per share go up by arithmetic, before anything good happens at all.
- 1
Combine the earnings1 day
Both companies' forecast earnings are added on a consistent basis.
- 2
Cost of the consideration1 day
Interest foregone or paid on cash, and new shares issued for paper.
- 3
Adjustments1–3 days
Synergies, transaction costs, amortisation of what was acquired, and tax.
- 4
Per share1 day
Combined earnings divided by the new share count, compared with the acquirer alone.
Which synergies count — The acquirer decides. Including savings that have not happened is where this analysis is usually bent, and it is the first thing to strip out.
Is accretion the question — The board decides. A deal can add to earnings per share and destroy value, and the arithmetic that shows why fits on one line.
Who is on the deal
| Who | Side | What they are actually for |
|---|---|---|
| The acquirer's board | Buy side | Asks this question before any other, because it is the one its own shareholders will ask. |
| The analyst | Neither | Combines the two sets of earnings and the cost of the consideration. |
| The acquirer's shareholders | Neither | Are the people the answer is about, and they are diluted or not on day one. |
| The equity research analysts | Neither | Will publish their own version within hours of the announcement, on public numbers. |
- Desk
- Valuation & Deal Analysis
- Measures
- The effect on the acquirer's earnings per share
- Not
- A statement about whether value was created
- Driven by
- The relative multiples, and how the deal is paid for
- Where it is bent
- Synergies that have not happened yet
What decides whether it completes
Not how hard this is, and not a rating — there is deliberately no total. It says which of five blockers decides whether this transaction happens at all, in the same order on all 70 transaction types so they can be compared. This publication's own reading; see the notice below.
- Pricematters
- Financingmatters
- Approvalbarely applies
- Diligencedecides it
- Executiondecides it
What decides it here. The arithmetic is trivial and the inputs are not. Synergies that have not happened, transaction costs left out and financing assumed at a rate nobody has quoted are where this analysis is bent — and it is bent often, because it is the number the board actually asks for.
3 · IntermediateHow it runs in practice
The rule of thumb
Ignoring synergies and costs, a cash deal is accretive when the multiple paid is lower than the buyer's own multiple. For a share deal, compare the two price-to-earnings ratios directly: a buyer on a higher multiple issuing shares to acquire a company on a lower one is accretive by construction.
This is why highly rated companies acquire and lowly rated ones are acquired, and why the direction of a deal frequently says more about the two share prices than about the two businesses.
What a proper analysis contains
- Both companies' forecast earnings, on a consistent basis and for the same period.
- The financing cost — interest on new debt, or foregone interest on cash used.
- New shares issued, at the actual exchange ratio.
- Synergies, phased realistically rather than assumed in full from day one.
- One-off costs of achieving them, which land in the first two years.
- Amortisation of intangible assets recognised on acquisition, which reduces reported earnings without using any cash.
Where it is bent
Almost always at the same three places: synergies included in full from the first year, transaction and integration costs excluded, and financing assumed at a rate nobody has actually quoted. Strip those out and a surprising number of accretive deals become dilutive.
Adjusted, and why it appears
Companies frequently present the analysis on adjusted earnings, excluding amortisation of acquired intangibles and one-off costs. There is a real argument for that — the amortisation is a non-cash consequence of the accounting — and there is also a pattern in which the adjustment is the difference between accretive and dilutive.
4 · AdvancedThe numbers & the documents
Why accretion is not value creation
Consider a buyer on twenty times earnings acquiring a target on twelve times, in cash, with no synergies. Earnings per share rise. But nothing about either business changed: the same cash flows exist, now owned differently, and the buyer paid a premium for the privilege.
What has actually happened is that the buyer applied its own high multiple to earnings the market valued at a lower one. Whether the market continues to do so is the question, and if it decides that the acquired earnings deserve their old multiple, the buyer's own multiple falls — leaving higher earnings per share and a lower share price.
That is not a theoretical concern. It is the mechanism behind the pattern in which serial acquirers show rising earnings per share and falling ratings.
What the market actually looks at
Two things beyond the accretion figure: whether the synergies are credible, and whether the price implies the buyer paid away more than the value created. The first is answered by whether the number decomposes into named actions; the second by comparing the premium paid with the announced synergies, which is an arithmetic anybody can do from the announcement.
The breakeven synergy
A useful and underused calculation: how large would the synergies have to be for the deal to break even in value terms, given the premium paid. If the answer is larger than the announced figure, the buyer's own shareholders are being asked to fund the difference — and stating it that way is more informative than any accretion table.
Where this belongs among the methods
It is not one of the valuation methods and it is presented alongside them because it is what the board will ask. Keeping it separate — analysis on one page, value on another — is the honest presentation, and merging them is how a financing decision gets mistaken for a valuation.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow people on the deal think about it
Now say it back
Close the page and give Accretion and dilution in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — name both sides and what each one is actually trying to get.
- What has to happen, in order — the three or four stages, not the whole timetable.
- Where the money comes from — cash, new shares, or borrowed; somebody has to fund it.
- What kills it — the ordinary way, not the dramatic one.
Where this transaction shows up elsewhere
- MediumValuationDeskThe arithmetic underneath every transaction: discounted cash flow, comparables, precedent transactions, the buyout…