Problem Cases 14.18 Interpreting Market-to-Book Ratios
• Bristol-Myers Squibb has the highest market-to-book ratio since it reflects the largest excess of
ROCE over its COE from the rest of its comparison. Their price-earnings ratio for the year is
almost with the average for the rest of the companies, reflecting that its earnings are likely
constant and do not likely include substantial temporary income items. A high number of years
of excess earnings at the ROCE of its current year required to generate a market-to-book ratio of
13.9, due to the large dividend payout percentage of 77%. If the dividend payout ratio is 44%,
the required years of excess earnings would be only 15.5 years.
• Warner-Lambert also reflects a high market-to-book ratio of 13.0 but a lower ROCE of 35% and
5.1 % historical growth in earnings. The price earning ratio for the current year suggest that the
company earnings for the current year include some negative transitory items. Its recent ROCE is
in understated. The long 35% ROCE can be expecting for the current year and the excess over
the COE capital would be higher and it will justify a higher market-to-book value.
• Eli Lilly’s market-to-book is 12.4 even though its ROCE is the lowest compared to the rest of the
company. But, the price-earnings ratio reflects extremely high, prompting that earnings for the
current year include some negative temporary items. Hence, the ROCE for the current year
could understates their long-term ROCE, and the excess of ROCE over the cost of equity capital.
It shows a high COE capital for them and reduces the excess return. The market apparently
