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Stock Market Valuation Exceeds Its Components' Actual Value
An anonymous reader writes: James Tobin, a Nobel Prize-winning economist, developed a concept called "Q-value" — it's the ratio between two numbers: 1) the sum of all publicly-traded companies' stock valuations and 2) the value of all these companies' actual assets, if they were sold. Bloomberg reports that the continued strength of the stock market has now caused that ratio to go over 1 — in other words, the market values companies about 10% higher than the sum of their actual assets. The Q value is now at its highest point since the Dot-com bubble. Similar peaks in the past hundred years have all been quickly followed by crashes.
Now, that's not to say a crash is imminent — experts disagree on the Q-value's reliability. One said, "the ratio's doubling since 2009 to 1.10 is a symptom of companies diverting money from their businesses to the stock market, choosing buybacks over capital spending. Six years of zero-percent interest rates have similarly driven investors into riskier things like equities, elevating the paper value of assets over their tangible worth." Others point out that as the digital economy grows, a greater portion of publicly traded companies lack the tangible assets that were the hallmark of the manufacturing boom.
Now, that's not to say a crash is imminent — experts disagree on the Q-value's reliability. One said, "the ratio's doubling since 2009 to 1.10 is a symptom of companies diverting money from their businesses to the stock market, choosing buybacks over capital spending. Six years of zero-percent interest rates have similarly driven investors into riskier things like equities, elevating the paper value of assets over their tangible worth." Others point out that as the digital economy grows, a greater portion of publicly traded companies lack the tangible assets that were the hallmark of the manufacturing boom.
Stock valuations are based not only on actual assets, but future growth and earnings potential. If I buy company X, it's because I think company X has a good product, business plan, and management and is going to be able to grow faster than inflation and faster than their competitors. I certainly don't want them to liquidate their current assets and give me my money back.
Intellectual property, trademarks, goodwill and copyrights are propping up stock prices like you wouldn't believe.
The small investors are sitting on the sidelines, keeping their cash from inflating and popping a bubble. Stock buybacks are keeping the market afloat, as many corporations want to keep Wall Street happy than reinvest the money back into the economy to keep Main Street happy.
Similar peaks in the past hundred years have all been quickly followed by crashes.
statistical historical trends, the bedrock of science rears its ugly head oncemore...
Now, that's not to say a crash is imminent experts disagree on the Q-value's reliability.
s/experts/investors/. Laszlo Birinyi is an investor, but for all intents and purposes economics shouldn't be misconstrued as a science. most of it is, at best, premised on laughably distorted statistics designed to reduce uncertainty among investors and promote open trading on stock exchanges. The employment of utterly bullshit mathematics in the art of economics is the reason high speed trading systems have the ability to "undo" sales or purchases with impunity. Large firms also have this ability because without such a control feature markets could be plunged into a dark age from which no amount of bailout would save the cloistered elite. Economics is the sack of magic chicken bones that investors wave over the market and quickly dismiss once wrack and ruin occur as "events that could not have been foreseen."
Good people go to bed earlier.
How is Q different than the usual Price-to-Book ratio, which formally has the same english definition of the share price to the per-share Asset value of the company? The price-to-book value doesn't go below 1 usually because a leveraged buyout of the company could fund it self by selling off the pieces. The Q-value seems to define assets as replacement value which is unclear. Is replacement value to be taken as what the assets would trade for in their used shape, or what they would cost to buy new.
Some drink at the fountain of knowledge. Others just gargle.
amazing how often that phrased is used after a crash by the same people who said anyone questioning market valuations on way up "does not understand the market"...
Also, looking at this graph of Q-ratio, I notice that Q-ratio does not predict the 1992 crash or the 2009 crash (reputed to be a bigger crash than the great depression).
For this hypothesis, what observations would invalidate the predictions made by this theory?
But maybe I'm not spending enough time looking at the numbers, maybe I'm not reading deeply enough.
Perhaps we should look at the "percent from its arithmetic mean", or maybe the "change from its geometric mean", or the "real S&P composite and the Q-ratio adjusted to its arithmetic mean", or the "net worth over market values outstanding"...
All of which can be found on this fine article.
If we look at the numbers in enough ways, I'm sure we'll find something that has a P < 0.05, then we can publish!
NO OTHER PLACE, other than real estate, precious metals, art, education for yourself, a private business you start, etc.
You're right. Let me rephrase that. I've never met a rich stock analyst who made his money by doing exactly what he told everyone else to do.
Seven puppies were harmed during the making of this post.
Precious metals are only worth something because other people want them. Because they think the metals are worth something because other people want the metals because they think they're worth something because... They're pretty, they're partly lasting and they're rare. Until they're not: aluminum used to be a valuable metal. Now I coat my armpits with it every morning, and half the metal objects I own are aluminum.
If you're expecting a big crash, you're better off purchasing items of utility or improving your land for raising food.
...which won't matter in the least if the "big crash" is big enough. People won't want gold or silver, they'll want guns and canned food.
I'm an engineer too. I used to think as you did. After getting an MBA it widened my perspective. I'm still an engineer, but now I understand how modern finance benefits society. Allocating capital efficiently is valuable. Decreasing interest rates is valuable. Deconstructing a debt it various risk components and selling those risks to person who are best equipped to understand those risks is also valuable. I encourage you to learn about finance. No, it is not as cool as engineering, or is it as useful, but you are mis-characterizing it.
--AC