Tobin’s Q is one of the three main broad valuation metrics that I follow and update. The other two being Professor Robert Shiller’s CAPE and Market Value of U.S. Equities as a Percent of GNP. With today’s release of the Flow of Funds report for Q2 2011 we can update Tobin’s Q.
Currently, Tobin’s Q is at 1.01.
To learn how to calculate Tobin’s Q on your on, please read this previous article.
You will notice that on my graph I marked 0.65 as fair value and not 1.0 like most statistical measurements of fair value. The reason for this is capital stock, the denominator, is routinely overstated lowering the value of Q. This is discussed further in the book “Valuing Wall Street: Protecting Wealth in Turbulent Markets” by Andrew Smithers and Stephen Wright.
The Q ratio is currently 55% above fair value. While this suggests that the U.S. stock market as a whole is over-valued, using this data as a timing tool is an improper way to interpret broad market valuation metrics. The Q ratio’s strength, along with the other two metrics, is as a measurement of risk. Readings above fair value imply a heightened risk that equity markets will experience below-average long-term returns. With Tobin’s Q so far above its fair value the risk of below-average long-term returns is high.
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