Tobin's q

A graph of Tobin's q for the US market from 1900 to 2003. By looking at the graph you can easily tell when the market was overvalued or undervalued. When Tobin's q spikes upward (like at 1929 or 1999) the market is expensive. The data was collected by [Andrew Smithers].

Tobin's q^{[#endnote_spelling]} compares the value of a company given by financial markets with the value of a company's assets. It was developed by James Tobin (Tobin 1969). It is calculated by dividing the market value of a company by the replacement value of its assets:

Tobin's q = [\mbox / \mbox]

Another use for q is to determine the valuation of the market as a whole. The formula for this q is: [\mbox / \mbox]

Contents

1 Application
2 Variables
3 Tobin's marginal q
4 Criticism
5 See also
6 Notes
7 Sources

Application

If the market value reflected solely the recorded assets of a company, Tobin's q would be 1.0.

If Tobin's q is greater than 1.0, then the market value is greater than the value of the company's recorded assets. This suggests that the market value reflects some unmeasured or unrecorded assets of the company. High Tobin's q values encourage companies to invest more in capital because they are "worth" more than the price they paid for them.

On the other hand, if Tobin's q is less than 1, the market value is less than the recorded value of the assets of the company. This suggests that the market may be undervaluing the company.

Variables

Tobin's q reflects a number of variables, and in particular:

The recorded assets of the company.
Market sentiment, reflecting, for example, analysts' views of the prospects for the company, or speculation such as bid rumors.
The intellectual capital of the company.

Since Tobin's q reflects a number of variables it can only be an approximation of the value of intellectual capital. Many companies now seek to develop ways to measure intangible assets such as intellectual capital. See balanced scorecard.

Tobin's marginal q

Tobin's marginal q is the ratio of the change in the value of the firm to the added capital cost for an increment to the capital stock.

Criticism

Tobin's q as compared with capital expenditures relative to GDP. While q seems to predict expenditures for the first half of the graph, by the 1970s things begin to break down and even in the 1990s, when the q ratio reaches record highs, only moderate expenditures result.

Doug Henwood, in his book Wall Street, argues that the q ratio fails to accurately predict investment, as Tobin claims. "The data for Tobin and Brainard’s 1977 paper covers 1960 to 1974, a period for which q seemed to explain investment pretty well," he writes. "But as the chart [see right] shows, things started going awry even before the paper was published. While q and investment seemed to move together for the first half of the chart, they part ways almost at the middle; q collapsed during the bearish stock markets of the 1970s, yet investment rose." (p. 145)

Notes

↑ Tobin's q is sometimes written as "Tobin's-q", "Tobin's Q" or simply Q. It is also called Tobins Quotient, since the Q stands for Quotient.

Sources

Tobin J. (1969) "A general equilibrium approach to monetary theory", Journal of Money Credit and Banking, Vol 1No 1 pp 15-29

Smithers, Andrew; & Wright, Stephen (2000). Valuing Wall Street: Protecting Wealth in Turbuluent Markets. McGraw-Hill. ISBN 0-07-135461-1

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