q-ratio q-valueThe Q-ratio is one of the methods to estimate the fair value of the stock market. It is defined as the total price of the stock market divided by the replacement cost of all its companies.

To put it more simply, the Q-ratio shows how much do we have to pay to buy the stock market compared to how much it would cost to build it up from scratch.

The Q-ratio is a fairly simple concept, but timely to calculate; fortunately, the US Federal Reserve provides the data on a quarterly basis.

To compare how much the companies cost with how much it would cost to rebuild them seems like a clever and objective way to measure the fair value the stock market. And looking back at “Q:s” history it has been of great value for investors using it.

The basic logic behind the Q-ratio is that if the “Q” is above 1.0, then the market is valuing the present stocks more than it costs to reproduce them; making them overvalued. If it is below 1.0, then it cost less to invest in stocks than it cost to reproduce them, thus making it more profitable to invest in the stock market than creating new companies.

On contrast to the P/E-ratio, the Q-ratio, is independent from the interest yield for comparison analysis. This makes the “Q” an easy and objective way to measure markets.

One of the drawbacks with the Q-ratio is that you have to trust the FED releasing the correct data, unless you wanna calculate the replacement cost of every stock by yourself.

Most people would intuitively think that the value of Q would be around 1 or a bit above in long-run. But its long-term value is close to 0,7. This is probably due to the fact that most firms assets are generally booked too high.

It is a shame that most amateurs in the market does not prefer to use the Q-ratio instead of P/E-ratios or dividend yields, both of which need to be compared to interest rates and other measures to be understood in their context.

Today the Q-ratio is a bit above 1 making the stock market overvalued by 40-50%.

I hope you enjoyed this article! Feel free to leave a comment.

 

Chart below shown for a historical view and is not recently updated

q-ratio historical chart

Chart from: http://mla.homeunix.com/q-ratio/