What is accretion / dilution?
Accretion/dilution analysis tests a single, blunt question about an acquisition: does it raise or lower the acquirer's earnings per share? If pro forma EPS after the deal is higher than it would have been standalone, the deal is accretive; if lower, it is dilutive.
It is the first quantitative screen run on almost any M&A deal because it is fast and it speaks the language public-company management and shareholders care about. EPS is the headline number markets watch, so whether a deal helps or hurts it is an early signal of how the transaction will be received.
The important caveat: accretion is not the same as value creation. A deal can be accretive to EPS and still destroy value — for example, if it is funded with cheap debt that loads on risk, or if the acquirer overpays. Accretion/dilution measures the earnings arithmetic, not whether the price was right.
How the analysis works
The mechanics combine the two companies and weigh the cost of the financing against the earnings acquired.
- Combine the earnings. Add the target's projected net income to the acquirer's, plus expected after-tax cost synergies.
- Subtract the cost of financing. If paid in cash or debt, subtract the after-tax interest on the new or foregone funds. If paid in stock, account for the new shares issued.
- Adjust for deal accounting. Incremental depreciation and amortization from writing assets up to fair value, plus any new financing effects, reduce pro forma earnings.
- Compute pro forma EPS — combined net income divided by the new total share count — and compare it to the acquirer's standalone EPS. Higher is accretive; lower is dilutive.
The intuition behind the result
The quickest mental model for an all-stock deal: compare the P/E multiples. A buyer with a higher P/E acquiring a target at a lower P/E is generally accretive, because it is issuing expensive shares to buy cheaper earnings. The reverse — a low-P/E buyer paying up for a high-P/E target — tends to be dilutive.
For cash and debt deals, the test is whether the after-tax yield on the earnings acquired exceeds the after-tax cost of the financing. When earnings yield beats financing cost, the deal adds to EPS. This is also why a low interest-rate environment makes more deals look accretive — cheap debt lowers the hurdle, which is exactly why accretion alone is a weak proxy for value.