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Tobin's q

Tobin's q is a ratio of all U.S. equities outstanding to total replacement value of all nonfinancial nonfarm corporate business. It is one tool that can be used to gauge the overall valuation attractiveness of the stock market.

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Expanded Definition

Tobin's q is regularly published in the Flow of Funds tables provided by the Federal Reserve Board. Since 1945, the average value for the q-ratio has been 71.93, which means the market value of all equities outstanding in the U.S. has usually sold for about 72% of estimated replacement value. The maximum value from 1945 to 2007 was 183.9 reached in 1999 during the dot.com bubble and the minimum value was 33.1 in 1948.

Here is a historical chart of Tobin's q:

Tobin's q.png

As you can see from the chart, Tobin's q has historically been an excellent timing indicator for the overall market price level. Tobin's q hit its highs (above 1.00) during strong bull, or bubble-like, markets and hit its lows (below 0.50) during periods of severe pessimism, such as the hyperinflation, high-interest rate decade of the 1970's. The book Valuing Wall Street includes a chart of Tobin's q showing similar timing characteristics during the first half of the twentieth century.

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