A higher P/E company acquiring a lower P/E company will be deemed accretive or dilutive under which condition?

In the context of mergers and acquisitions, an all-stock deal refers to a transaction where the acquiring company pays for the target company entirely with its own stock. When a higher P/E (Price-to-Earnings) company acquires a lower P/E company in an all-stock deal, it can result in an accretive transaction if the earnings yield of the acquired company is greater than that of the acquirer's P/E ratio.

Here’s why the situation is that way:

• The P/E ratio reflects how much investors are willing to pay per dollar of earnings. A higher P/E suggests that the acquirer is valued highly by the market, potentially leading to lower earnings yields. Conversely, a lower P/E indicates that the target company may have a higher earnings yield (the inverse of P/E).

• When the higher P/E company issues new shares to pay for the acquisition of the lower P/E company, it effectively swaps its higher-yield shares with those yielding less market hype (but potentially better intrinsic value).

• If the earnings generated by the lower P/E company exceed the dilution effect of issuing new shares, this can enhance the overall earnings per share (EPS) of the combined entity, making the deal accretive.

Other scenarios