Foundations of Financial Management(18th ed). McGraw-Hill Higher Education (US)
Chapter 20 Exercise 7
The earnings are equivalent to the E in the P/E in the P/E ratio. By extension, the underlying question is in terms of the relation between the post-merger share price and earnings. Several factors impact the share price and earnings in the scenario post-merger as below:
Market Sentiments: The expectations of a good return in the long-term with prospects of growth for the company will raise the P/E ratio as a result of the high stock price as compared to average or low earnings for the stock.
Immediate reaction: In general, the stock price for a company is driven up when mergers are announced. After the deal is finalized and merger is undertaken, in line with it the market corrects itself as per the deal price. In such cases, the reaction in many cases is independent of the actual earnings for the companies.
Revenue changes: The earnings are based on the growth of both companies and the result of mergers on earnings are not entirely predictable. The stock price is an indicator of the investor’s expectations and they are often variable to the actual earnings in either direction.
One-time expenses: The companies undertaking mergers may have many one-time expenses including logistics, infrastructure, etc. that can even be added as write-offs and are non-recurring. While the overall trajectory can be deterministic, the one-time expenses are reflected in the earnings and may skew the balance sheet temporarily post-merger.
