Q Ratio

By looking at the graph you can easily tell when the market was overvalued or undervalued. When Tobin's q spikes upward (like at 1929 or 1999) the market is expensive.

The data was collected by Andrew Smithers.

Tobin's q is a ratio comparing the value of the stocks of a company listed in the financial market with the value of a company's equity book value. It is calculated by dividing the market value of a company by the replacement value of the book equity:
Tobin's q =
Another use for q is to determine the valuation of the market as a whole.The formula for this is:


Application
If the market value reflected solely the recorded assets of a company, Tobin's q would be 1.0.
If Tobin's q is greater than 1.0, then the market value is greater than the value of the company's recorded assets. This suggests that the market value reflects some unmeasured or unrecorded assets of the company.

High Tobin's q values encourage companies to invest more in capital because they are "worth" more than the price they paid for them.

If a company's stock price (which is a measure of the company's capital market value) is £2 and the price of the capital in the current market is £1; the company can issue shares and with the revenue invest in capital. In this case q>1.
On the other hand, if Tobin's q is less than 1, the market value is less than the recorded value of the assets of the company.Although empirical evidence reveals that his discoveries are not as tight as one would have thought. This is largely because firms do not blindly base investment decisions on movements in the stock price rather they examine the present value of expected profits and future interest rates.
Variables
Tobin's q reflects a number of variables, and in particular:
The recorded assets of the company.
Market sentiment, reflecting, for example, analysts' views of the prospects for the company, or speculation such as bid rumors.
The intellectual capital of the company.
Since Tobin's q reflects a number of variables it can only be an approximation of the value of intellectual capital.

Many companies now seek to develop ways to measure intangible assets such as intellectual capital. See balanced scorecard.
Tobin's marginal q
Tobin's marginal q is the ratio of the change in the value of the firm to the added capital cost for an increment to the capital stock.
P/B ratio
In inflationary time, Q will be lower than P/B ratio, conversely it will be higher than Q.
Criticism
Doug Henwood, in his book Wall Street, argues that the q ratio fails to accurately predict investment, as Tobin claims."The data for Tobin and Brainard’s 1977 paper covers 1960 to 1974, a period for which q seemed to explain investment pretty well," he writes. "But as the chart shows, things started going away even before the paper was published.