Tobin's Q – Definition and History for the US Stock Market

April 6th, 2021 by 

This page computes the Tobin's Q Ratio for the United States stock market. It provides a historical Tobin's Q graph and summary statistics, including average, median, minimum, and maximum for the indicator.

Tobin's Q for the United States

What is Tobin's Q?

Tobin's Q, or the Tobin Q Ratio, is the market value of a security or market divided by its asset replacement cost. It's sometimes referred to by the shorthand q ratio.

The ratio was popularized in the 1970s by Yale's James Tobin. He theorized that securities' market value divided by their replacement cost should roughly find equilibrium around 1. In that way, you can apply the Q Ratio to a market and any subset down to an individual firm – find the market value of the thing and divide it by its replacement cost (or a reasonable proxy)

Nicholas Kaldor

Arguably, the ratio should be called Kaldor's v instead of Tobin's Q.

Kaldor first proposed the ratio in his response to Professors Paul A. Samuelson and Franco Modigliani called the Marginal Productivity and the Macro-Economic Theories of Distribution.

In it he noted that security market equilibrium requires a factor that is responsive to market price fluctuations. Enter v or value:

[The market value of securities vary] not only with the rise in dividends and earnings per share, but also with the "valuation ratio" (v)-i.e. the relation of the market value of shares to the capital employed by the corporations (or the "book value"of assets).

Nicholas Kaldor (1966), Marginal Productivity and the Macro-Economic Theories of Distribution

Although he didn't write out the formula in the succinct way it exists now, his formula underpins the Q Ratio's more popular form.

Tobin's Q Formula

The formula for Tobin's Q Ratio or Kaldor's v for a single corporation is:

Tobin's\ Q\ Ratio=\frac{Equity\ \&\ Liabilities\ Market\ Value}{Equity\ \&\ Liabilities\ Replacement\ Value}

As 'replacement value' is hard (or impossible!) to come by, usually book value is a reasonable approximation.

The formula for Tobin's Q Ratio or Kaldor's v for a group of corporations, country stock market, or index is:

Tobin's\ Q\ Ratio=\frac{Equity\ \&\ Liabilities\ Market\ Value}{Equity\ \&\ Liabilities\ Replacement\ Value}

Tool Methodology

As the tool is looking at aggregate market valuation, we necessarily use approximations for market value and replacement cost.

Both estimates come from the Federal Reserve's Z.1 Financial Accounts of the United States Report (quarterly). We're using these two series:

  • Market Value: Nonfinancial Corporate Business; Corporate Equities; Liability, Level
  • Replacement Cost/Book Value: Nonfinancial Corporate Business; Net Worth, Level

We could use something like the Wilshire 5000 to estimate daily, but it's hard to chase book value. For faster updates on the market, try the CAPE Ratio/Shiller PE, S&P 500 Price to Peak Earnings Ratio, or the Buffett Indicator.

Questions About Tobin's Q

What are good values for Tobin's Q?

Tobin's q, in theory, has an equilibrium around a value of 1.

  • <1: Undervalued. (The replacement cost of the security/index/market is more than the market value.)
  • >1: Overvalued. (The replacement cost of the security/index/market is less than the market value.)

In practice, we can't know the actual book value or replacement cost for a security, index, or country stock market… so you need to allow space around the center. You might also allow some intangibles too – for example, some financial companies might have better models, or you think some company has better strategy, execution, or synergy.

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