INTERPRETING MARKET-TO-BOOK RATIOS. Exhibit 14.13 pres- ents data on market-to-book ratios, ROCE, the cost of equity capital, and price-earnings ratios for seven pharmaceutical companies. (Note that price-earnings ratios for these firms typically fall in the 30-35 range.) Exhibit 14.13 also provides historical data on the five-year average rate of growth in earnings and dividend payout ratios for each firm. The data on excess earnings years represent the number of years that each firm would need to earn a rate of return on common shareholders' equity (ROCE) equal to that in Exhibit 14.13 in order to produce value-to-book ratios that equal the market-to-book ratios shown. For example, Bristol-Myers Squibb would need to earn a ROCE of 48.9 percent for 58.3 years in order for the present value of the excess earnings over the cost of equity capital to produce a value-to-book ratio that matches the market-to-book ratio of 13.9.
Required
Assume that market share prices for each firm are reasonably efficient. That is, do not simply assume that the market has over- or undervalued these firms. Considering the theoretical determinants of the market-to-book ratio, discuss the likely reasons for the relative ordering of these seven companies on their market-to-book ratios.
Text Book: Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective By James Wahlen, Stephen Baginski, Mark Bradshaw.