If The Eatery has a market-to-book ratio of 3.2, what does this ratio indicate?

• A. The market values The Eatery at 3.2 times its book value, suggesting investors expect strong future growth.
• B. The Eatery's liabilities are 3.2 times its equity.
• C. The Eatery's earnings per share are 3.2 times higher than its book value per share.
• D. The Eatery's stock price is undervalued compared to its book value.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of the market-to-book ratio. This ratio compares the market value of a company (its stock price multiplied by the number of shares outstanding) to its book value (the value of its net assets as recorded on the balance sheet). It is a measure of how investors value the company relative to its accounting value.
2. Step 2: Analyze the given market-to-book ratio of 3.2. This indicates that the market values The Eatery at 3.2 times its book value. Investors are willing to pay a premium over the book value, which often suggests expectations of strong future growth or profitability.
3. Step 3: Evaluate the options provided in the problem. The correct interpretation of the market-to-book ratio is that it reflects the market's valuation of the company relative to its book value, not its liabilities, equity, or earnings per share.
4. Step 4: Eliminate incorrect options. For example, the statement 'The Eatery's liabilities are 3.2 times its equity' is unrelated to the market-to-book ratio. Similarly, 'The Eatery's earnings per share are 3.2 times higher than its book value per share' confuses earnings with valuation metrics.
5. Step 5: Conclude that the correct interpretation is: 'The market values The Eatery at 3.2 times its book value, suggesting investors expect strong future growth.' This aligns with the purpose of the market-to-book ratio as a valuation metric.