Earnings accretive

Acquisitions are said to be earnings accretive or earnings enhancing if they increase EPS and earnings dilutive if they decrease EPS.

An accretive acquisition is not necessarily good any more than a dilutive acquisition is necessarily bad.

  • Acquisitions paid for with cash tend to be accretive because they reduce cash or increase debt, swapping interest payments for returns on an actual business. The effect of many acquisitions is to reduce PE but also to increase risk thanks to higher gearing.
  • The acquired business may have a lower PE because it is slower growing or is higher risk.
  • The expected improvement expected may assume synergies (most often cost savings) that may not actually be delivered.
  • Operational gearing may be increased by deferred consideration or other continuing agreements with the seller of the acquired business.
  • The increase in earnings may result from, or be exaggerated by, the accounting treatment of the acquisition. For example, by writing down the value of assets on acquisition (to fair value) and thus reducing future depreciation.

In general, companies will try to spin an accretive acquisition as necessarily good and work hard to justify a dilutive acquisition. Investors should be sceptical and look at the nature of the combined business and at a full range of valuation measures (EV/EBITDA, price/cashflow, etc.)