NAMED AFTER famed economist James Tobin, Tobin’s Q compares the stock market’s total value to the value of corporate assets. This might sound suspiciously like price-to-book value. But book value reflects the value at which assets are carried on a corporation’s books, while Tobin’s Q looks at corporate assets using current values.
This number is available every three months, compliments of the Federal Reserve. In its massive “Financial Accounts of the United States,” you need to look for table B. 103, which details the “Balance Sheet of Nonfinancial Corporate Business.” Line 45 compares the stock market’s overall value to the current value of assets owned by corporations. Some of these corporate assets are listed at their market price, while others are valued at their replacement cost.
The Fed’s fourth quarter 2018 report shows stocks trading 4.5% above the value of corporate assets, down from a 23.9% premium three months earlier. At first blush, that reading suggests U.S. shares were slightly overvalued at year-end 2018, because stock investors were effectively purchasing corporations for a price that was a tad above the value of their assets.
Analysts, however, don’t pay much attention to the absolute number, because the replacement values are likely overstated (or, to put it another way, companies could replace their current assets with assets of comparable condition for less than the stated replacement cost). Instead, analysts pay attention to how today’s ratio compares to the historical ratio. On that score, things look far worse: The 4.5% premium, while a vast improvement over 2018’s third quarter, was well above the historical average discount of 30%. That tells us that stocks were still somewhat overvalued at the end of 2018’s fourth quarter. For more on Tobin’s Q over time, head to AdvisorPerspectives.com.
Tobin’s Q shouldn’t be used as a short-term trading signal. As with the Shiller P/E, Tobin’s Q has indicated that stocks have been overvalued for much of the past quarter century. That suggests that perhaps average valuations have moved into a permanently higher range. If that has happened, it’s a mixed blessing: We may not get a big market decline—but, given today’s rich valuations, we also aren’t likely to enjoy impressive long-run gains.
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