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Alternative investments EPS BOOTSTRAPPING

Finance basics
EPS bootstrapping or the bootstrap earnings e ect is a practice in corporate
Modern portfolio theory
nance used  to boost the earnings per share (EPS) and to increase the stock
Bond valuation
price. Bootstrapping in mergers and acquisitions is a common practice that
Equity valuation
investors should be aware of. That’s  because the bootstrap e ect has no
Accruals ratio ·
economic bene ts to a company. The merger produces increased earnings per
Acquisition Goodwill ·
share but the combined value of the rms is still equal to the sum of the
Acquisition Method · separate parts.
Adjusted Discount Rate ·
Approach On this page, we explain how EPS bootstrapping works, and provide a
Analyst Perception of · numerical example that illustrates the e ect. We implement the example using
Mispricing
an Excel spreadsheet.
Burmeister, Roll, and ·
Ross model

Capital Structure · E PS BOOT S T R APPI NG

Irrelevance Proposition
Capitalized Cash Flow ·
Method
Carhart 4 Factor Model ·
Cash Conversion Cycle ·
Bootstrapping occurs in the context of M&As. In this case, the acquirer buys a
company with a low Price-Earnings (P/E) through a stock swap. The goal is to
boost the post-acquisition EPS of the newly created company and to increase
the stock price.

Claims valuation · Thus bootstrapping automatically occurs when acquirer’s Price-Earnings is

approach
higher than the Price-Earnings of the target company and a stock transaction is
Clean Surplus ·
Relationship executed to perform the merger or acquisition. Of course, the whole approach

Combined ratio · is just accounting trickery. In principle, the market will recognize what is
happening and the acquirer’s price will adjust to account for the e ect. In that
Combined Ratio After ·
Dividends (CRAD) case, the P/E of the company will be unchanged. 
Conglomerate Discount ·
If, however, investors are not careful in reviewing the actions of the acquiring
Continuing Residual ·
Income company, they may be tricked. In that case, the stock price does not fully adjust
and the stock price may be boosted.
Country risk premium ·

Degree of Operating · BOOT S T R APPI NG E PS E XAMPL E

Leverage
Let’s have a look at a bootstrapping EPS example. Suppose we have two
Diluted Earnings per ·
Share companies, where one company is acquired by the other company.
Discount for Lack Of ·
Control-DLOC

Discount for Lack of ·

Marketability (DLOM)

Dupont Analysis Excel ·

Template

Earnings persistence ·

Economic Value Added · BOOT S T R APPI NG E PS L ONG T E R M E FFE C T S

EPS bootstrapping · While bootstrapping may provide a temporary increase in the stock price if
Equivalent Annual · investors don’t realize the trickery, the e ect will disappear over time. The only
Annuity approach
way to keep the Price-Earnings arti cially high is to continuously buy other
Excess Earnings Method ·
(EEM) companies. This is not possible, so eventually the P/E will adjust and the stock

FCFE Coverage Ratio ·

price will go down.

FCFF vs FCFE ·

Fundamental Factor · S UMMAR Y

Model
We discussed bootstrapping. The bootstrap e ect occurs when a high P/E rm
General Residual Income ·
Model acquires a low P/E rm in a stock transaction. In the process, the acquirer
Gordon Equity Risk · exchanges higher priced shares for lower priced shares.
Premium Model

Grinold and Kroner ·

Model

Growth Accounting ·
Equation

Guideline Public ·
Company Method
T HE ABOV E T OPIC IS RELAT ED T O T HE FOLLOWING SET OF
T OPICS:
H-Model ·
1. CAPE ratio
Ibbotson-Chen model ·
2. Anchoring
Justi ed PE · 3. Justi ed PE
Justi ed Price-to-book · 4. Bootstrapping Spot Rates
multiple 5. Molodovsky e ect
Justi ed Price-to-Sales ·
ratio

Justi ed ratios ·
 DOWNLOAD THE EXCEL SPREADSHEET
LBO Model ·

Macroeconomic Factor · Want to have an implementation in Excel? Download the Excel le: EPS
Models Bootstrapping template
Merger motives ·

Pastor-Stambaugh ·
Model

Pecking Order Theory ·

PEG Ratio ·

Piotroski F-score ·

PRAT Model ·

Present Value of Growth ·

Opportunities (PVGO)

Pure-play method ·

Sum Of The Parts ·

Valuation

Venture Capital ·
Valuation Method

Yardeni model ·

Dividend discount model ·

PE ratio ·

CAPE ratio ·

Dividend yield ·

Arbitrage pricing theory ·

Derivative valuation
Performance measurement
Risk management
Behavioral Finance

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