CFAI text V3, P.167~169, Why Tobin’s q > 1 => security prices are overvalued (Example 16) and additional investment shall be profitable (P167) ? Tobin’s q < 1, => security prices are undervalued (Example 16) and additional investment shall be unprofitable (P167) ? My intuitions are contrary : overvalued => additional investment shall be unprofitable undervalued =>additional investment shall be profitable On the other hand, in 2nd paragraph on P.167, it is stated : Tobin’s q below, at, or above the COMPARISON VALUES is interpreted as maket being undervalued, fairly valued, or overvalued. What are the COMPARISON VALUES ? Is it that COMPARISON VALUE =1 as in Example 16 ?
that paragraph is stating that if q=2, stock is overvalued, then if the company buy one dollar of asset, the stock market will give you a $2 increase in market value. original shareholders just make another $1 profit from initial $1 investment. so it is profitable. correct me if I am wrong. CY
Any other comment ?
Tobin’s q is mean reverting. Tends to revert back to 1 or historical average.
it’s market value of assets/replacement cost, so if you are less than 1, it may mean that the market itself is undervaluing assets… and the company. if over 1, then it makes sense to invest in new capital since the new capital is “cheap” (the assets according to this formula worth more than the cost of them), like my boy on the banks of the river charles says above, seems like free money if over 1… but perhaps the market is overvalued. I think it’s all supposed to be very mean reverting, so sort of makes sense then. Aside from the 2 EOC item sets that they did on this new section, anyone have good q’s on these? The book has a little blue box example also with the basic formulas on Tobin’s and Equity Q. I definitely could see an item set on this new stuff. But maybe it’s wishful thinking since it’s not that hard and more or less the only new stuff this year.
rivercharlesy Wrote: ------------------------------------------------------- > that paragraph is stating that if q=2, stock is > overvalued, then if the company buy one dollar of > asset, the stock market will give you a $2 > increase in market value. original shareholders > just make another $1 profit from initial $1 > investment. so it is profitable. > > correct me if I am wrong. > > > CY Thanks, but I still don’t quite understand it. Does it mean that the company could also issue new shares in higher price? This can bring the Tobin’q back to 1 or its equilibrium value. ---------------------- BTW, this Tobin’s Q was in L3 curriculum before, dropped and come back again. http://www.analystforum.com/phorums/read.php?13,735135,735140#msg-735140
deriv the company could issue more stock but it would not change the market cap …according to corporate theory the additional stock would dilute the stock price not changing the market cap
The company can use buy the asset, then the replacement cost increases, and the tobin’s q ratio decrease. – This is just my thinking, not from the book.
deriv i told u to quit thinking!!! how will it finance the deal? again the stoclk price should reflect if it uses cash/issues euity or debt
Pe, back to the original question. It depends on who is using tobin q, company or investor. For companies, higher tobin’s q, the more profitable its investment. The firm can issue new share or issue new debt. But it may not explain what the book said. I agree with you, issuing new issues won’t change market cap.
Correct me if I’m wrong.
i think i get what you are implying the company is able to finance a large market cap through actual book value…so for example my book value is 2000$ yet i use it to generate a market value of 1mil …careful u are wading deep here,…first of all the company rates on equity and debt must be crushing and the only justification for this is if the market is forward looking assuming a new patent/idea /discovery to justify this…so i guess in summary i agree with what u are saying a company would always like to have a high Tobin q while an investor is looking for a lower Tobin Q my mind is a jumbled mess
Example 16 on P169. Solution to 1: If Tobin’s q is greater than 1.0, then the market is valuing a company at more than it costs to replace its assets. Either security prices must fall or the company should continue to invest in new assets until the ratio returns to its equilibrium. If Tobin’s q is below 1.0, then security prices are undervalued because new businesses cannot be created as cheaply as they can be bought in the open market. Either security prices must rise or the company should sell some of its assets until the ratio returns to its equilibrium ------