The Q Ratio, often called Tobin’s q, is a ratio comparing a public company’s market value to its book (or total asset) value.
The market value refers to the amount a firm is worth on the market (by multiplying shares by the going market share price), while the book value refers to the collective value of a company’s net assets (less depreciation, debt, etc.).
Tobin’s q is viewed as a snapshot of a firm's financial performance: how much would it cost to replace a company’s total assets vs. how much it would get for selling all of its shares at the current going price.
Scoring the Q Ratio
Nobel Laureate James Tobin, and his collaborator William C. Brainard of Yale University, were the minds behind the Tobin’s q calculation. They hypothesized that a fairly-priced company’s book and market values should be relatively equal. The metric thus allows investors to see which company’s shares are overpriced, and which are good value for their dollar.
Additional factors such as company intangibles and market rumours can also affect the ratio. A score between 0 and 1 is a low q score, whereas scores greater than 1 are high. Scores closest to 1 indicate relatively equal book and market values.
Low q (between 0 and 1)
Let’s say a company – Q-Lo, Inc. – isn’t doing so well on the TSX. But the company’s assets are in good standing and it has been steadily paying down debt, driving up book value. In this case, Q-Lo’s book value is higher than its market value: it would cost more to replace the company’s assets than the total stock of the company are worth. Investors estimate the Tobin’s q for Q-Lo Inc. is at 0.3, meaning the firm is undervalued. Buy up.
High q (over 1)
Now take Hi-Queue & Co., Q-Lo Inc.’s direct competitor. The firm has been unable to pay down LOC and outstanding debts, negatively impacting its book value. Yet the market buzz around Hi-Queue shares is spiking prices thanks to rumours that the company will settle a major deal in coming weeks. Hi-Queue’s market value is greater than its book value, meaning the company could replace all of its assets by selling its market shares at current prices, and still have money leftover. Investors estimate the Tobin’s q for Hi-Queue & Co. is at 1.79, meaning the firm appears overvalued. Sell!
When is Tobin’s q Useful?
The Q Ratio is helpful when making investment decisions and determining fair value for stock purchases. It is also a way of measuring a firm’s financial performance, and provides a snapshot of how the company is faring on the markets – and on the books – in that moment.