Q Ratio: What is it?

 I have previously discussed the Sharpe ratio and other measures for evaluating individual investments as well as the broader market.

A recent Wall Street Column mentioned the Q ratio.

So, here is a brief explanation of the Tobin Q Ratio. The 1981 Nobel Laureate James Tobin came up with the Q Ratio, which measures a firm’s assets in relation to the overall market’s value. In other words, a ratio of the net worth of a company and replacement cost of the firm to indicate if the company is undervalued or overvalued. For instance, if Xerox has 80M $ of assets and has 10 million outstanding shares at $ 6 each, then the net worth of the company is: 10M x $6 = $60M divided by the total asset or replacement value or $ 80 = 0.75 (Q Ratio) . This means that Xerox is currently worth more than its assets and it is UNDER valued (Q Ratio between 0-1). If the Ratio is over 1.0, the company would have been overvalued. The overall market today is higher than 31 of the 35 previous market tops and the ratio is 69% above its arithmetic mean. This is because the combined market value of all the companies on the stock market is lower than their replacement costs and the Q Ratio exceeds 1. An all-time Q Ratio high at the peak of the Tech Bubble was 1.63.Unfortunately, the ratio is not very timely and 2-3 months behind but apparently is the best predictor of market corrections of > 20%.
 Comment: But, like a lot of people I do not have time or the knowledge to make these bets so I am content not to follow the market every minute or hour content that I have made my bet in terms of my allocation for the long term. I may not get the 20% return some friends are getting but then I was not getting them prior to the market crash a few years ago when the tech bubble burst either!   --------------------------