The Q ratio, or Tobin’s Q, can be a reliable measure of stockmarket value. Introduced as a concept by Nobel Laureate Professor James Tobin in 1969, it compares the total market value of the companies whose shares make up an index with their net worth as measured by their replacement cost (what it would cost to recreate their businesses).
Historically, the Q ratio has always reverted to a long-term average of about 0.64 – usually via increases or decreases in stock prices, as these move far more rapidly than net worth. So comparing the current value with this figure allows investors to gauge the current degree of over- or under-valuation of a market.
Q can be calculated for many markets such as the S&P 500 or the FTSE, but data constraints render it much less useful for other markets or individual shares. Critics of the Q ratio claim that its emphasis on tangible assets – such as plants and inventory – unfairly neglects important intangibles, including brands and intellectual property.
• Watch Tim Bennett’s video tutorial: What is Tobin’s Q ratio?