TOBIN'S Q: MARKET VALUE/REPLACEMENT COST

James Tobin presented an alternative to traditional financial measures of value by comparing the market value of an asset to its replacement cost. His measure, called Tobin's Q, has several adherents in academia but still has not broken through into practical use, largely because of problems in getting the necessary information.

Definition

Tobin's Q is estimated by dividing the market value of a firm's assets by the replacement cost of these assets.

In cases where inflation has pushed up the replacement cost of the assets or where technology has reduced the cost of the assets, this measure may provide a more updated measure of the value of the assets than accounting book value. The rationale for the measure is simple. Firms that earn negative excess returns and do not utilize their assets efficiently will have a Tobin's Q that is less than 1. Firms that utilize their assets more efficiently will trade at a Tobin's Q that exceeds 1.