Tobin's Q is a financial measure of the replacement costs of a firm's assets. At first glance, both the Investopedia definition and the Wikipedia definition state that a low Q indicates an undervalued stock, so a value investor might take that as a buy signal. Well, we here at Alfidi Capital don't stop at some breezy pop-culture investment waystation. I didn't get my MBA for nothing, so let's consider what academicians have to say about using Tobin's Q:
See that line I bolded? A firm earning excess profits may very well have a durable competitive advantage, which Buffett-style value investors like. A high Tobin's Q would therefore be a very good buy indicator for a stock. So what to do? Here's a thought: Use Tobin's Q in conjunction with other traditional value style metrics, like earnings growth and low debt. A high Q may very well be a good sign of a stock Uncle Warren likes. You'll see me try to apply this approach in future research on the Alfidi Capital main site.
An interesting news item prompted me to bring up this topic:
Long story short, the article contends that Tobin's Q for the S+P 500 will drop further in the tradition of past recessions, which saw the ratio plunge below its historical average. The article also quotes other money managers and strategists who have varying opinions on Tobin's Q, mostly because they also look to other indicators to confirm their analysis. Nothing wrong with healthy debate.
I'll confine my use of Tobin's Q to discussions of individual stocks and avoid the macro perspective. I don't have access to the high-powered data sources most economists use for such things (because I'm too cheap to pay), and even if I had the data I'd be mindful of the limitations of aggregating economy-wide estimates of intangibles like intellectual capital. Calculating a single stock's Tobin's Q can be as easy as looking at a balance sheet if you truly understand a company's history and operating environment.
This measure of performance is not used as often as either rates of return or price-cost margins. If a firm is worth more than its value based on what it would cost to rebuild it, then excess profits are being earned. These profits are above and beyond the level that is necessary to keep the firm in the industry.
The advantage of using Tobin's q is that the difficult problem of estimating either rates of return or marginal costs is avoided. On the other hand, for q to be meaningful, one needs accurate measures of both the market value and replacement cost of a firm's assets.
See that line I bolded? A firm earning excess profits may very well have a durable competitive advantage, which Buffett-style value investors like. A high Tobin's Q would therefore be a very good buy indicator for a stock. So what to do? Here's a thought: Use Tobin's Q in conjunction with other traditional value style metrics, like earnings growth and low debt. A high Q may very well be a good sign of a stock Uncle Warren likes. You'll see me try to apply this approach in future research on the Alfidi Capital main site.
An interesting news item prompted me to bring up this topic:
A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.
Long story short, the article contends that Tobin's Q for the S+P 500 will drop further in the tradition of past recessions, which saw the ratio plunge below its historical average. The article also quotes other money managers and strategists who have varying opinions on Tobin's Q, mostly because they also look to other indicators to confirm their analysis. Nothing wrong with healthy debate.
I'll confine my use of Tobin's Q to discussions of individual stocks and avoid the macro perspective. I don't have access to the high-powered data sources most economists use for such things (because I'm too cheap to pay), and even if I had the data I'd be mindful of the limitations of aggregating economy-wide estimates of intangibles like intellectual capital. Calculating a single stock's Tobin's Q can be as easy as looking at a balance sheet if you truly understand a company's history and operating environment.
