CFA CFA Level 3 Tobin’s qonfusion

# Tobin’s qonfusion

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I am having trouble understanding the interpretation of Tobin’s q.

In the first paragraph of page 154 (SS7, Reading 19 of the CFAI curriculum), it says that Tobin’s q is equal to 1 in equilibrium. If it is greater than 1 for an individual company, it means that the market is valuing their assets at more than their replacement costs, so future investment should be profitable (undervalued). By contrast, if less than 1, future investment should be unprofitable (overvalued).

In the second paragraph, it talks about Tobin’s q at the market level, and seems to say the opposite: If greater than 1 then the market is overvalued, and if less than 1 then the market is undervalued.

Why would it be opposite for the overall market than it is for an individual company? It’s the same equation, same ratio, except the numbers are aggregated. Help me understand this.

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Ah ok, got it. Not completely contradictory.

Tobin’s q can be used at individual company or aggregate economy level.

If Tobin’s q is >1 for an individual company, “the additional capital investment should be profitable for the company suppliers of financing” simply means that assuming the ratio stays constant, it’s attractive to invest more capital (debt or equity) simply because the company is probably utilising them well enough to derive the above book value that was invested. Profitable doesn’t mean under or over valued. That ratio is only meaningful (in terms of valuation) if compared across similar companies in the industry.

But for the aggregate Tobin q, which is normally mean reverting, it is used as an indicator of over/under valuation.

I hope I’m making sense.

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No problem @padniaki. When you start a new thread, choose the ‘ask a question’ option, for questions with specific answers. You should be able to do that now.

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Wow, actually that makes perfect sense. Thank you so much.

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@padniaki, can you take a snapshot of the notes and post it here for reference? Seems to be contradictory, I recall the interpretation of the latter.

Use http://www.imgur.com for your images, and the attach image URL function above.

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And the above image is directly from the curriculum, btw.

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Thank you!

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If it is greater than 1 for an individual company, it means that the market is valuing their assets at more than their replacement costs, so future investment should be profitable (undervalued). By contrast, if less than 1, future investment should be unprofitable (overvalued).

I find that sentence contradictory in particular, as if it’s over 1, it is overvalued according to Tobin’s theory, and how does that mean that it’s profitable/undervalued…

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you’re welcome @padniaki ðŸ™‚ I can see that you highlight usefully, unlike me, where the whole page is just coloured by the end of a session!