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According to Tobin’s Q, equities in the U.S. are valued about 10% above the cost of replacing their underlying assets — higher than any time other than the Internet bubble and the 1929 peak.
The edited excerpt above, and the edited commentary below, comes from an article entitled The Last Two Times This Happened, Stocks Crashed which can be read here in its entirety along with an assortment of charts to support its contention.
A definition:
Tobin’s Q assesses equity valuations by comparing the total value of stock prices with the value of underlying assets such as plants, inventory, and equipment, adding up the value of the equity, then buying all the assets to see if some cash is left over and, if there is, then stocks are overvalued.
An explanation:
- companies are taking advantage of record low borrowing costs and voracious demand for corporate bonds by issuing record amounts of debt.
The problem:
- the proceeds aren’t going towards capex (i.e. future growth and productivity) but rather towards
- buybacks which not only inflate EPS but also
- management’s equity-linked compensation.
- while stocks climb ever higher, thanks to a perpetual bid from price insensitive corporate management teams and investors (and central banks) front-running the buybacks, productive assets deteriorate, jeopardizing top line growth and, in turn, the ability to service debt costs down the road. Here are a few graphics that tell the story.
Conclusion:
- congratulations to the Fed and to corporate America. Thanks to a protracted period of ultra-low rates and a combination of corporate short-sightedness and greed, stock prices have been driven to their third-largest disconnect with underlying productive assets in history.
Not everyone agrees with the above point of view as discussed in an article by Cullen Roche entitled Thoughts On Tobin’s (Useless) Q which can be read in its entirety HERE.
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