When bootstrapping, the acquiring firm purchases: A) slow growth firms with low price-to-earnings (P/E) ratios. B) high growth firms with high price-to-earnings (P/E) ratios. C) high growth firms with low price-to-earnings (P/E) ratios. Your answer: C was incorrect. The correct answer was A) slow growth firms with low price-to-earnings (P/E) ratios. Bootstrapping involves a high growth, high P/E ratio firm purchasing slow growth firms with low P/E ratios. The low P/E implies that the acquiring firm can purchase the firm “cheap” since its stock exhibits a higher price for a given level of earnings. The end result is that the earnings of the two firms are added together, while the exchange of high P/E company’s shares are made at a less than 1 to 1 ratio for the low P/E company shares. Thus, earnings per share will increase due to the lower total number of shares outstanding. ---- quick question. i know that in bootstrapping, a high p/e firm buys a low p/e firm so got that part. confused on the first part of the answer (why is the purchasee a slow growth firm?). if the purchasee has low p/e doesnt that mean that earnings are high relative to price meaning that growth is high? i dont agree with the part of the answer that says “The low P/E implies that the acquiring firm can purchase the firm “cheap” since its stock exhibits a higher price for a given level of earnings.” i think that the stock exhibits a LOWER price for a given level of earnings–if it the price were higher than the p/e would be HIGHER not lower.
C is incorrect because in CFA land high growth firms don’t trade at a low P/E. The section about bootstrapping in corp fin. CFA curriculum specifically says low growth firms for bootstrapping.
i remember this now thanks a lot
I need to go back to text on this, but this is what my logic is: High growth firm with low P/E is a rare fish, unless it has some other fundamental problems. Anyone would buy such a firm/stock handsdown. Now, given that it is difficult to find high growth firm with low P/E, and our objective is to buy a low P/E firm, because our own P/E is high, we will settle for a low growth low P/E firm. And as javanon86 said, it is specifically mentioned in the text that bootstrapping is to buy low growth firm, it removes all doubts. Regarding your question: “since its stock exhibits a higher price for a given level of earnings”. I think ‘since its stock’ implies ‘since its own stock’, that is the stock of the acquirer. If it does not imply this, it is not correct as you have pointed out.
i noticed this as well. “its stock” is referring to the “acquirer’s stock”. if you make this connection and combine with what jvanon86 said everything makes sense. high p/e firm (high growth) buys low p/e firm (low growth) in a bootstrapping.
I think it may be important to consider ‘synergies’. This is where the value can be created by purchasing a slow growth/low P/E firm. If the aquire is in a related business, then they may be able to recognize additional value that an ordinary investor/unrelated acquire will not recognize