The advantage of the Acquirer’s Multiple over a PE ratio is that it rewards companies with more cash and punishes companies with more debt. The PE ratio completely ignores those balance sheet items.
Let’s look at an example. The two companies make the same amount of net income ($8M). The market cap of Company 1 is $100M and the market cap of Company 2 is $120M. At first glance, the first company seems cheaper. It has a PE ratio of 12.5, while the second company has a PE ratio of 15. But don’t let the PE ratio fool you, Company 2 is a much better deal with an Acquirer’s Multiple of 6.7 relative to 10.0 Multiple for Company 1. Do you want to buy a business with low cash and high debt or a business with high cash and low debt? Company 2 has $50M of cash and only $10M of debt, while Company 1 has only $10M of cash and $50M of debt. Company 2 is obviously a much better deal. It can use the extra cash to pay off its debt, do share buybacks or pay a dividend. Unfortunately, the PE ratio completely ignores these balance sheet items.
