Accretion and dilution

When one company buys another, its shareholders want to know a simple thing: will earnings per share go up or down? Accretion and dilution analysis answers that. It compares the acquirer’s earnings per share (EPS) pro forma for the deal, that is, with the target folded in and the financing in place, against its EPS on its own. If the combined figure is higher, the deal is accretive; if lower, dilutive[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.]. It is a standard analysis for any acquirer that has a share price, and one that is easy to misread.

How the test is built

The calculation walks from operating income to earnings per share, adding the target and the cost of paying for it along the way. One standard text gives it in ten steps[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.]:

1. Start with the acquirer’s projected operating income (EBIT).
2. Add the target’s projected EBIT.
3. Add the synergies expected from the combination.
4. Subtract the extra depreciation and amortization that arises from writing up the target’s tangible and intangible assets.
5. Subtract the acquirer’s existing interest expense.
6. Subtract the interest on any new debt raised to pay for the deal, which gives pro forma earnings before tax.
7. Subtract tax at the acquirer’s rate, which gives pro forma net income.
8. If shares were issued as part of the price, add them to the acquirer’s fully diluted share count.
9. Divide pro forma net income by the pro forma share count: pro forma EPS.
10. Compare it with the acquirer’s standalone EPS.

Steps 6 and 8 are where the form of payment enters. Pay in cash and the share count does not change, but interest on the borrowing (or forgone interest on the cash) reduces net income. Pay in shares and there is no new interest, but the earnings are spread over more shares[2Source 2Giuliano Iannotta, Investment Banking: A Guide to Underwriting and Advisory Services (Springer, 2010), §7.7.2, “EPS Accretion/Dilution”.].

A worked example

Another textbook works it through on round numbers. The bidder has 30 million shares at €20 and net income of €60 million, so its EPS is €2.00 and its price-to-earnings ratio is 10. The target has 10 million shares at €15 and net income of €25 million: EPS €2.50, P/E 6[2Source 2Giuliano Iannotta, Investment Banking: A Guide to Underwriting and Advisory Services (Springer, 2010), §7.7.2, “EPS Accretion/Dilution”.].

Line	Bidder alone	Paid in shares	Paid in cash
Net income of the bidder	60.0	60.0	60.0
Net income of the target		25.0	25.0
After-tax cost of the cash (150 at 10%, 30% tax)			(10.5)
= Combined net income	60.0	85.0	74.5
Shares outstanding (millions)	30.0	37.5	30.0
Earnings per share	2.00	2.27	2.48
Change		+13.3%	+24.2%

Source: The example in the textbook cited below, restated; figures in millions of euros except per share. The textbook prints the share deal’s EPS as 2.26; 85 over 37.5 is 2.267, shown here rounded, and the +13.3% follows from the unrounded figure.

In the share deal the bidder issues 7.5 million new shares, at an exchange ratio of 0.75 of its own shares for each target share, so the combined €85 million of net income is spread over 37.5 million shares and EPS rises by about 13 percent, to roughly €2.27 (the textbook prints €2.26). In the cash deal the bidder spends €150 million of cash that had been earning 10 percent, or borrows it at 10 percent; either way it gives up €10.5 million of after-tax income, but the share count stays at 30 million, so EPS rises further, to €2.48[2Source 2Giuliano Iannotta, Investment Banking: A Guide to Underwriting and Advisory Services (Springer, 2010), §7.7.2, “EPS Accretion/Dilution”.]. Both versions are accretive.

The rule of thumb

The share deal was accretive for a reason that generalises. In an all-stock transaction, buying a target with a lower P/E than the acquirer’s is accretive: the acquirer is paying fewer times earnings for the target’s profits than the market pays for its own, so each new share brings in more earnings than the old ones carry[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.]. Buying a higher-P/E target is dilutive by the same arithmetic. Synergies can rescue such a deal, and transaction charges such as the extra depreciation and amortization can sink one that looked fine[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.].

Acquirers like to be accretive from “Day One”, and investors tend to cheer it. But because many deals are long-term strategic moves and stock markets look ahead, the analysis is usually run for the next two or so projected years rather than the current one, so that the target’s growth and the synergies are captured[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.]. It works as a screen: as a rule, acquirers do not pursue deals that are dilutive over the whole projection period, with exceptions for a fast-growing target whose earnings arrive later than the usual two-year horizon[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.].

The standard text’s own illustration shows how much rides on the details. In a half-stock, half-cash deal, combined EBIT of $2,066.4 million, including $100 million of synergies, less $36.7 million of write-up depreciation and amortization, less the acquirer’s $140.2 million of existing interest and $180.3 million of new interest, taxed at 25 percent, gives pro forma net income of $1,281.9 million; spread over 173.6 million shares, 33.6 million of them new, that is EPS of $7.39 and accretion of 8.6 percent. Without the synergies the same deal is accretive by only 2.1 percent, and the analysis reports the pre-tax synergies at which it would break even[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 7, “Accretion/(Dilution) Analysis”, pp. 343–346.].

What it misses

Two valuation texts make the same objection from different directions: EPS accretion is arithmetic, not value.

The first points out that the rule of thumb assumes the market keeps the acquirer’s P/E where it was. But the target had a lower P/E for reasons, higher risk or lower growth for instance, and a forward-looking market should lower the acquirer’s multiple after the deal. Whether the price rises or falls then depends on whether the price paid was above or below what the target was worth, and the target’s P/E, and the accretion, are beside the point. The author concedes that in the short run the bet on appearances can pay off, citing a study of 224 transactions in which accretive acquirers’ shares kept rising for eighteen months[3Source 3Aswath Damodaran, Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2nd ed. (Wiley, 2006), ch. 15, “The Value of Synergy”, the section “Accretive Acquisitions”.].

The second gives a counterexample in numbers. An acquirer worth $1.6 billion, with $80 million of net income and 40 million shares, pays $500 million in cash for a target the market prices at $400 million, with no operating improvements to come; it overpays by $100 million. Financed with debt at 6 percent before tax, the deal is nevertheless accretive, because the target’s $30 million of after-tax earnings exceed the $19.5 million of after-tax interest: EPS rises from $2.00 to $2.26 while value is destroyed. Paid instead in 12.5 million new shares, EPS still rises, to $2.10, “a result of mathematics rather than value created by the deal”[4Source 4Tim Koller, Marc Goedhart and David Wessels, Valuation: Measuring and Managing the Value of Companies, 7th ed. (Wiley, 2020), ch. 31, “Mergers and Acquisitions”, the section “Focus on Value Creation, Not Accounting”.]. The same passage notes the mirror image: a fast-growing target bought at 30 times earnings will dilute EPS for a couple of years and may still create value, if its growth and its return on capital are high enough[4Source 4Tim Koller, Marc Goedhart and David Wessels, Valuation: Measuring and Managing the Value of Companies, 7th ed. (Wiley, 2020), ch. 31, “Mergers and Acquisitions”, the section “Focus on Value Creation, Not Accounting”.]. Its conclusion is the one to keep: stock markets react to the value a deal is expected to create, not to its effect on accounting numbers, and focusing on the accounting is dangerous[4Source 4Tim Koller, Marc Goedhart and David Wessels, Valuation: Measuring and Managing the Value of Companies, 7th ed. (Wiley, 2020), ch. 31, “Mergers and Acquisitions”, the section “Focus on Value Creation, Not Accounting”.]. A test that can be passed by borrowing to buy earnings measures the arithmetic, not the judgement.

Line	Acquirer alone	Cash deal	Share deal
Net income of the acquirer	80.0	80.0	80.0
Net income of the target		30.0	30.0
After-tax interest on 500 of new debt		(19.5)
= Net income after the deal	80.0	90.5	110.0
Shares (millions)	40.0	40.0	52.5
Earnings per share	2.00	2.26	2.10

Source: The hypothetical deal in the valuation text cited below, restated; pretax cost of debt 6 percent, tax rate 35 percent.

Where it sits in the toolkit

Accretion and dilution is one page of a merger model, beside the enterprise valueEnterprise value and equity valueEquity value is what the shares are worth; enterprise value is what the whole business is worth to all who fund it. How they link, and why cash is subtracted.Terms and methods · revised 28 September 2026 · 921 words · 4 sources · 5 min bridge that sets the price, the comparable companiesComparable companies analysisComparable companies analysis values a business from the multiples similar public companies trade at: choosing peers, spreading the numbers, picking a range.Terms and methods · revised 28 September 2026 · 1,109 words · 3 sources · 5 min that frame it, and the EBITDAEBITDAEBITDA is earnings before interest, taxes, depreciation and amortization: how it is calculated, why bankers compare firms with it, and why it is not cash flow.Terms and methods · revised 28 September 2026 · 1,060 words · 4 sources · 5 min multiples that everyone quotes. For an investment banking analyst it is a standard exhibit in a pitch; for the reader it is a reminder that a number can go up for reasons that have nothing to do with anyone being better off.

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  title        = {{Accretion and dilution}},
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  year         = {2026},
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