Why is it considered accretive when the acquiring company purchases a company with a lower PE ratio than its own?
Intuitively, I am not able to see why a target company that has a lower PE ratio would be accretive to shareholders of the acquiring company.
You are essentially buying the same earnings for cheaper.
I would think of this in terms of cost of acquisition vs yield to understand it intuitively.
For example, if Company A's P/E ratio is 20x and Company B's P/E ratio is 10x, then Company A acquiring Company B is accretive. If you flip the P/E ratio of the companies, then it is 1/20 (5%) and 1/10 (10%), respectively.
With these fractions/percentages, you can think of this as Company A's Cost of Acquisition and Company B's Yield. Assuming this is an all stock deal, Company A's stock (their cost of acquisition) to acquire Company B is 5%. In return, they are yielding Company B which is 10%. Cost of Acquisition Yield = Accretive
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