Accretion and Dilution
A deal can raise or lower the buyer's earnings per share. Raising it is accretive; lowering it is dilutive, and a simple calculation shows which one a deal is under given assumptions.
How a deal changes the buyer's earnings per share. Earnings per share (EPS) is net income divided by the number of shares outstanding. A deal changes both parts of that fraction. The target's earnings are added to the buyer's earnings, and the way the buyer pays changes the cost and the share count. Paying with new shares raises the number of shares. Paying with cash or debt leaves the share count alone, but the buyer gives up the interest its cash was earning or takes on interest cost on new debt.
If combined EPS after the deal is higher than the buyer's EPS before it, the deal is accretive. If it is lower, the deal is dilutive. If it is the same, the deal is neither.
A simple accretion and dilution calculation. The calculation runs in a few steps, using assumptions given for the deal:
- Start with the buyer's net income and share count, and compute its EPS before the deal.
- Add the target's net income to the buyer's.
- Adjust for how the deal is paid for: subtract the after-tax interest on any new debt, or the after-tax interest income lost on cash used, and add any new shares to the share count.
- Divide the combined net income by the new share count to get EPS after the deal.
- Compare the two EPS figures. Higher after the deal means accretive; lower means dilutive.
A rough intuition: when the buyer pays in stock, the deal tends to be accretive if the target's earnings relative to the price paid are strong compared with the buyer's own earnings relative to its share price. The result always depends on the assumptions fed in, so changing the price, the financing mix or the target's earnings can flip the answer.
The limits of EPS as a measure of value. Accretion or dilution describes what happens to one accounting figure, EPS, in the near term. It does not say whether the buyer paid a fair price. A deal can be accretive and still destroy value, for example if the price is far above what the target's future cash flows justify. A deal can be dilutive at first and still create value if the target's growth or synergies arrive later.
The result also leans on the financing choice and on the assumptions used, and it ignores risk, timing of cash flows and the cost of the capital used. For that reason it is read alongside value-based tools such as discounted cash flow, not in place of them.
