Can a firm improve its P/E ratio through acquisition? How does this work?
Yeah, it’s called bootstrapping. Let’s say your a company that has a 20 P/E. You acquire a company with a 10 P/E ratio and wipe out their common stock. So you’re adding more to your denominator and keeping the same numerator.
Your adding the same amount to your NUMERATOR and less to your DENOMINATOR. When a high P/E firm acquires low P/E firm for stock consideration, it takes less shares for the high P/E firm to acquire all of the low P/E firm than a 1/1 ratio. The end effect is your earnings are simply additive, but the combined share amount is less than 1/1, artificially increasing earnings. Similar logic to share repurchase only being accretive to BVPS if the share price is less than original BVPS, or if using debt, earnings yield is greater than after-tax cost of debt.
markCFAIL Wrote: ------------------------------------------------------- > Your adding the same amount to your NUMERATOR and > less to your DENOMINATOR. > > When a high P/E firm acquires low P/E firm for > stock consideration, it takes less shares for the > high P/E firm to acquire all of the low P/E firm > than a 1/1 ratio. The end effect is your earnings > are simply additive, but the combined share amount > is less than 1/1, artificially increasing > earnings. > > Similar logic to share repurchase only being > accretive to BVPS if the share price is less than > original BVPS, or if using debt, earnings yield is > greater than after-tax cost of debt. If you look at example 3 on page 263 of the curriculum, you can see EPS increase, but the effect on share price is unknown. You cannot make any assumptions.