I thought if Tobin’s q < 1, then the market has undervalued the company/index, and investing in this undervalued stock should be profitable as the q will revert to 1, the equilibrium value. Agree? Why then does the book 3 page 167, first para last sentence state “… a Tobin’s q below 1 indicates further capital investment is unprofitable.” ?
It has to be compared to a historical average. Generally you look at <1 as good, however there are countries with historical averages of <=.75. The trick is it must be compared to the historical norm, at least according to the book. Automatically assuming <1 is good is a no-no. If no information is given, it would make sense to assume <1 is good. However if the question states something like Tobins Equity Q is .85 and supporting documents show long-term average is .75, you can assume the market is OVERVALUED not undervalued.
jbaphna Wrote: ------------------------------------------------------- > I thought if Tobin’s q < 1, then the market has > undervalued the company/index, and investing in > this undervalued stock should be profitable as the > q will revert to 1, the equilibrium value. Agree? > > Why then does the book 3 page 167, first para last > sentence state “… a Tobin’s q below 1 indicates > further capital investment is unprofitable.” ? With Tobin’s q lesser than 1, it simply means that the company is undervalued. Capital investment will only worsen the undervaluation and the company is better off buying back the shares. Like Paraguay pointed out, you still need to measure against historical Tobin’s q or measure against industry average to know if the company is “relatively” undervalued or overvalued. If that is not given then assume that anything less than 1 is undervalued and vice versa.
100 precent me.tega
As I re-read the first para on page 167, it becomes clearer that there are TWO perspectives (a) “Capital Investment” from company’s suppliers of financing…i.e. (new equity or debt) issues from these companies will not be hot IPOs…where as (b) the outstanding equities and debt that trade in secondary market are undervalued and would make a good investment for Investors. Agree?
if under 1.0, equity markets are undervalued becasue it assumes that everything is mean reverting, thus it must increase to get back to 1.0
mcap11 Wrote: ------------------------------------------------------- > if under 1.0, equity markets are undervalued > becasue it assumes that everything is mean > reverting, thus it must increase to get back to > 1.0 Don’t assume that read the text. Assuming 1.0 was the baseline. If the baseline is <1.0 it is mean reverting to the baseline.
so if under the baseline, it is undervalued. easy enough
right cuz u can buy the company and sell off the parts providing calcs are correct on the denominstor