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Tobin’s q, or The Q Ratio

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. Learn why it’s helpful.

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 valuerefers 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.

Fair Shares

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.

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Author

  • Lauren Turner
    Senior Sustainability Specialist
    Centre for Building Sustainable Value, Ivey Business School
    Master's in Environment and Sustainability, Western University

    Lauren completed a Bachelor of Health Sciences and a Master’s in Environment and Sustainability at Western University. She interned with the Network for Business Sustainability as part of the MES program, and continued to edit and contribute content to the network in the years following. She later completed a Master’s in Insurance and Risk Management from the MIB School of Management in Italy, where she focused on environmental risk mitigation strategies in the face of changing market sentiments towards low carbon. Lauren has worked primarily in the non-profit and higher-ed sectors in Toronto and London over the past decade. Her work has revolved around corporate social responsibility in mining and minerals governance, stakeholder engagement, project and program management, and writing/editing for corporate audiences. Her writing has focused on the intersection of sustainability and finance, access to capital, investor risk, consumer behaviour, and sustainable marketing. She is interested in conversations around how industry can hedge against risk and benefit financially from improving the sustainability of their operations.

    View all posts
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