In short – the profits added by the business Insimbi acquired was more than the interest it pays on the loans to buy it, by a wide margin.
And the company used enough cash in the deal to avoid diluting shareholders.
This means that earnings per share would increase – and the share price would follow.
Three tips to spotting acquisitions that will send a share price soaring
What you need to watch out for is that not all acquisitions send share prices up.
They sometimes send them down as well…
Fortunately, this isn’t down to guesswork.
If we can calculate the after deal earnings per share, we’ll know if the share price will head up or down with reasonable certainty.
But without doing that, there’s a couple of rules of thumb you can use to identify good acquisitions:
The deal must be at the right price
Look at what is being offered for an acquired business in comparison to the profits of the business. For instance – if the deal is for R200 million, and the business being acquired made a profit of R50 million we know that the payback period is 4 years. If the profit it made was only R20 million the payback period is 10 years – which suddenly isn’t that great…
The deal should not dilute current profits
Look at the PE ratio of the share you hold, in comparison to the business it is buying… In Insimbi’s case, Insimbi was on a PE of 7, while AMR Group (the company it acquired) had a PE of 4.65. That means that even had Insimbi paid for the deal with ONLY shares its earnings per share would still be higher because the company it had acquired a lower PE than itself.
The payment terms should be fair
Firstly – I prefer when companies pay for deals in tranches, determined by profit targets. So that if the business they buy does not deliver – they pay less.
Secondly – the deal should use a mixture of own cash, shares and debt. Too much debt is bad, as we all know. Too many shares may mean shareholder dilution. And companies normally don’t have the cash on hand to do deals with only cash.
I hope this gives you a better idea of how acquisitions can aid in share price growth – and how to spot good acquisitions from the bad ones.
I have uncovered two penny shares with massive deals in the pipeline this month.
These deals could put their gains on 50% - 100% within the next one to two years.
To find out more about these two companies check out my October issue of Red Hot Penny Shares
Here’s to unleashing real value