The benefit of the Acquirer’s A number of over a PE ratio is that it rewards firms with additional cash and punishes firms with extra debt. The PE ratio utterly ignores these steadiness sheet objects.
Let’s have a look at an instance. The 2 firms make the identical quantity of web revenue ($8M). The market cap of Firm 1 is $100M and the market cap of Firm 2 is $120M. At first look, the primary firm appears cheaper. It has a PE ratio of 12.5, whereas the second firm has a PE ratio of 15. However don’t let the PE ratio idiot you, Firm 2 is a significantly better take care of an Acquirer’s A number of of 6.7 relative to 10.0 A number of for Firm 1. Do you need to purchase a enterprise with low money and excessive debt or a enterprise with excessive money and low debt? Firm 2 has $50M of money and solely $10M of debt, whereas Firm 1 has solely $10M of money and $50M of debt. Firm 2 is clearly a significantly better deal. It may possibly use the additional money to repay its debt, do share buybacks or pay a dividend. Sadly, the PE ratio utterly ignores these steadiness sheet objects.