Tobin’s Q weighs in on market’s value

I’ve mentioned Shiller’s PE10 stock market valuation model in previous posts and how it had recently fallen to levels that historically have coincided with attractive long-term buying opportunities. Now another valuation model – Tobin’s Q – offers another take on the market’s current valuation.

Tobin’s Q is calculated as the combined market value of all companies divided by their total asset value (or replacement costs). A value of “1″ implies a perfectly valued market, while values above “1″ suggest overvaluation and values below “1,” undervaluation.

According to The Manual of Ideas, the latest Q ratio value is 0.43, far below fair value. While certainly a positive sign, they caution that when viewing the Q ratio in an historical context it is only a moderately bullish signal.

For example, like Shiller’s PE10, it can certainly go lower, and has – at least six previous times in history. And that’s more likely if the ratio is on a downswing – as it is now – then if it were on the upswing.

Still, the takeaway is a bullish one. And those who argue that the Q ratio level of 0.43 is bearish are focusing too closely on historical lows (for example, the ratio hit the 0.29 level twice in the past century) and are leaving themselves open to missing decades of strong returns.

Related posts:
Another take on Shiller’s PE10
Shiller: The market hasn’t been this cheap in decades
Online stock returns predictor based on Shiller’s P/E10
Market’s long-term rewards potentially “staggering”